2014-06-25 Poland - Reading Romanias Newspapers of Tomorrow

Erste Group Research
Special Report | Fixed Income | Romania

25 June 2014
Special Report: Romania

Qq
Poland - Reading Romanias Newspapers of Tomorrow?

Accelerated economic reforms in the early 90s made
Poland a front runner compared to Romania. A number of
economic indicators suggest that Romania is following in
Polands footsteps, albeit with a time lag of more than 6-7
Chief Economist BCR years, which means that the gap has not narrowed in the
Radu Crciun last decade. As time goes by, narrowing the gap might
+40373510424 prove challenging, since a number of opportunities have
radu.craciun@bcr.ro been lost and the brands of the two countries have already
been set in stone. In fact, the lack of coherent public
policies aimed at increasing Romanias attractiveness for
Senior Analyst foreign and local investors and boosting EU funding
Eugen Sinca increases the odds of increasing the development gap.
+40373510435 Last but not least, the educational gap between the two
eugen.sinca@bcr.ro countries and the significant time required before any
change in the education system is reflected in the
economy, suggests that, without immediate action in this
area, Romania risks being left even further behind.
A tale of two similar countries
Poland: best regional proxy for From an economic and social perspective, Romania and
Romania and therefore Poland share a number of important similarities. They are the
largest markets in Central and Eastern Europe, with
populations of 20 million and 38.5 million inhabitants,
respectively. Their economic structure is similar in many
aspects, with a bulky agricultural sector that accounts for 6.4%
of gross value added in Romania and 3.8% in Poland, well
above the 1.7% in the Eurozone. They are among the less
open economies in the region, with a share of exports and
imports of goods in GDP of 72% in Romania and 80% in
Poland, as compared to levels of between 130% and 170% of
GDP in the Czech Republic, Hungary and Slovakia. The stock
of foreign direct investments per capita is below EUR 5,000
both in Romania and Poland, while other countries in the region
range between EUR 8,000 and EUR 10,000.
Despite the similar demographic, geographic and economic

profiles with which the two countries started their journey
towards free market economies, the quality and timing of
economic decisions allowed Poland to accelerate its
development and leave Romania behind, according to most
macroeconomic and market indicators, meaning that Poland
qualified faster for EU membership and made its economy
more immune to the crisis.
could be used to anticipate future
developments in Romania Given that the two countries are largely similar, it would be a
logical and tempting step to use Poland as a proxy in order to
Erste Group Research Special Report Page 1
25 June 2014
anticipate future developments in Romania, based on the
assumption that, as long as the convergence play remains valid
for both countries, Romania might face similar opportunities
and challenges as Poland in the past. However, one should be
aware that timing is an important element in decision making,
meaning that, despite the fact that Romania might now take
some decisions taken by Poland years ago, the impact might
be much smaller, a typical example being the construction of a
strong capital market similar to the Polish one.
Long-standing economic development gap
GDP per capita puts Romania seven With a GDP per capita of EUR 7,093 in 2013 and an estimated
years behind Poland level of EUR 7,414 in 2014, Romania finds itself seven years
behind Poland. In 1990, Romania and Poland were on par with
their levels of nominal GDP per capita, just shy of the
equivalent of EUR 900. What happened in the early 90s made
a very significant difference. While Poland was pushing for the
restructuring and privatization of the state-owned sector,
Romania preferred to preserve it and to prop it up at any cost
in order to avoid social tensions. The result was that the
severe adjustments suffered by Poland in early 90s were faced
by Romania in the late 90s, when the Romanian economy
suffered a severe decline and then began to rise. By that point,
the development gap was already there.
Chart 1: Comparative real GDP dynamics (1989 = 100%)

250%
PL
200%
150% RO
100%
50%
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: Eurostat, IMF, BCR Research
Many economic, political and social events have shaped

Romanias and Polands economic development ever since, but
probably the most important driver of Polands superior
performance was its determination to open up its economy to
private investors and follow tough but necessary economic
reforms well before Romania. Better absorption of EU structural
funds also made a big difference in the recent past. The
development gap between Romania and Poland widened in the
first years of the transition to a market economy and persisted
after that, indicating that Romania found its way to a functioning
market economy much later and was then unable to unleash its
full growth potential.

25 June 2014
A look at real GDP dynamics since 1990 reveals that Romania
Romania decoupled from Poland over decoupled from Poland in two large time intervals. 1992-2000
two large time intervals: 1992-2000 was a lost decade for Romania, when stop-and-go public
and 2009-12 policies made foreign capital avoid Romania, depriving it of
badly needed capital and know-how for faster development.
During 2009-12 the gap increased even further as, while

Romania was posting a deep recession, Poland remained
surprisingly immune to the crisis and continued to post positive
growth rates. With its public finances in better shape in 2008,
Poland enjoyed a big fiscal stimulus package which
counterbalanced the headwinds from the external environment.
The inflow of EU funds and hosting of the Euro 2012
Championships secured a high level of public investments and
contributed to economic growth. Finally, Polands position as a
relatively closed economy, with lower exports in GDP compared
to other CEE countries, strengthened its resistance to the
Eurozone crisis.
Chart 2: Structural budget deficits (% of GDP)
2006 2007 2008

0.0
-1.0
-2.0
-3.0
-4.0
-5.0
-6.0
-7.0 Romania Poland
-8.0
-9.0
Source: European Commission
Unlike Poland, Romania fell into Being in an opposite, much weaker position, Romania was hit
recession, lacking strength to by the crisis. The highly expansionary fiscal policy conducted
conduct countercyclical fiscal policy before 2008, after the IMFs departure, exacerbated Romanias
fiscal vulnerability when the global crisis struck, leaving few, if
any, options for the government to implement countercyclical
fiscal policies and cushion the downturn. The strong reliance of
economic growth on private external debt prior to 2008 led to a
build-up of external vulnerabilities and added pressure on the
local currency. The build-up of macroeconomic imbalances
during the economic boom years of 2004-08 needed only a
trigger like the Lehman collapse to see the artificially inflated
economic growth burst immediately afterwards. Subsequent
monetary easing by the NBR after signing the precautionary
stand-by agreement with the IMF and EU in 2009 was too
gradual and was unable to counter-balance the severe fiscal
and current account correction, which in turn led to a sharp
decline in investments and consumption.
Looking forward, under current conditions, Romanias annual

economic growth could accelerate to around 4% by 2020,
which is very much the same economic growth rate projected
for Poland in the future. The development gap of seven years in
terms of GDP per capita would thus remain intact or would
25 June 2014
even widen in the absence of any significant pickup of
Romanias growth, triggered by stronger inflows of private
capital in economy and higher productivity in the public sector.
Chart 3: GDP per capita at purchasing power parity

(EU28=100%)
70
Romania Poland
60 17 pp
50
13 pp
40 17 pp
2007: Romania
joins the EU
30
2004: Poland
joins the EU
20
10
0
2004 2007 2012
Source: Eurostat, IMF, BCR Research
Romania to move to less energy intensive economy
Seven years behind Poland in Romanias energy efficiency is another facet of a long history of
terms of energy consumption per lack of determination by the authorities to tackle structural
unit issues in the economy. In spite of gradual progress in recent
years, Romania finds itself seven years behind Poland in terms
of energy consumption per unit of GDP. Industry has a stronger
footprint in Romanias gross value added, accounting for 34.3%
of the total as compared to 24.7% in Poland. Moreover, energy
intensive industries are commonplace and some of them need
additional investments to improve their energy consumption
profile. According to Eurostat, the manufacture of basic metals
and chemical industry, two of the most energy-intensive
industries, account for 2.2% of total gross value added in the
Romanian economy against 1.4% in Poland. On the other
hand, the service sector is much more developed in Poland,
where it accounts for GDP weight of 65%, compared to 50% in
Romania.
The delayed liberalization of energy prices or lack of any

political commitment to make changes in a predictable manner
has made the industrial sector and households less inclined to
follow energy efficiency programs. Eurostat data shows that the
2013 gas price for household consumers was 30% of the EU
average in Romania, well below the 75% in Poland. For
industrial consumers, the average price paid in Romania stood
at 54% of the EU average, while in Poland it was almost equal
to the average European price. A look at electricity prices
shows that Romanian households paid 65% of the average
European price (84% in the case of Polish households), while
Romanian industrial consumers were charged more than their
Polish counterpart and were very close to the European
average.

25 June 2014
Chart 4: Energy intensity of the economy expressed as

energy consumption per GDP (kg of oil equivalent per
1,000 euro)
2002
2004
2006
2008
2010
2012
600 600
550 550
500 500
450 450
7-year time
400 lag PL upper 400
scale
350 350
RO lower
300 scale 300
250 250
200 2001 200
2003
2005
2007
2009
2011
2013
2015
2017
2019
Source: Eurostat, BCR Research
Sectors which are less energy The situation leads us to believe that the future development of
intensive better positioned for future the Romanian economy will be much less energy intensive,
growth, while such as sustained growth in tradable services. The strong rise
of IT&C services in 1Q14 (almost 20% y/y) came after another
very good reading for FY13 (14%). This portrays an
encouraging picture of qualitative long-term changes in the
local economy. The hefty surplus of services balance in
balance of payments, both in 1Q14 (EUR 744mn, +27% y/y)
and in FY13 (EUR 2.7bn, +143% y/y), along with strong job
creation in the services sector, adds to this positive image.
traditional industries should On the other hand, traditional industries will find ways to
become more energy efficient to become more efficient or negotiate better pricing terms, taking
survive advantage of EU concerns to prevent economic migration to
cheaper energy countries. Last but not least, it is important that
Romania should continue to attract EU funds for increasing the
energy efficiency of buildings, because the final energy
consumption of population accounts for 35% of all energy
consumption in economy. The thermal rehabilitation of old
buildings could be an important growth driver for the
construction sector, in the absence of effervescent economic
activity in residential and infrastructure segments.

25 June 2014
Chart 5: Gross value added in total economy vs. gross

value added in energy in Romania (1999 = 100%)
180%
Gross value added in total
economy
160% Gross value added in energy

sector
140%
120%
100%
80%
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Romanias energy consumption The bottom line, as shown in the graph above, is that we
might decline in short term and rise believe that, following the same energy efficiency improvement
later pattern as Poland, despite facing positive growth rates,
Romanias energy consumption might decline over the next 1-2
years and rise only later. This means that the existing
production overcapacity is likely to be preserved unless reliable
export markets will be identified.
The presence of foreign capital in the economy is one of the

more favorable statistics for Romania, which posts a five-year
delay compared to Poland in terms of stock of foreign direct
investments per inhabitant. A number of comments can be
made in this respect.
Both countries have enjoyed strong FDI inflows
Although Romanias FDI per capita The graph shows that, after 2004, Romania enjoyed the same
shows a five-year time lag, the FDI boom as Poland in 2003-06. However, although the FDI
economic development lag is larger discrepancy is only five years, the GDP per capita lag is seven
years. We believe that this could be explained on the one hand
by the fact that a smaller number of people is involved in high
value added activities with, as discussed above, many more
being involved, for instance, in agricultural activities. Another
explanation could be the FDI destination, meaning the extent to
which it has been directed towards high value added productive
sectors or services or it has been brought in for more
speculative investments, such as real estate.

25 June 2014
Chart 6: Stock of foreign direct investments per capita

(EUR)
2000
2002
2004
2006
2008
2010
2012
5,000 5,000
4,000 PL upper 4,000

5-year time lag
scale
3,000 3,000
2,000 2,000
RO lower
scale
1,000 1,000
0 0
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
Romania relies more than Poland on The structure of foreign direct investments reveals that
capital inflows coming from Romania relies more than Poland on capital inflows coming
Eurozone from Eurozone economies. 82% of all foreign direct
investments that came to the Romanian economy by the end of
2012 originated from Eurozone countries, while the Polish
economy relied on the single currency area in 76% of cases.
Between 2009 and 2011, when the global crisis ravaged
financial markets, Poland attracted average annual inflows of
foreign direct investments of EUR 11.6bn (3.3% of GDP per
year). Romania was less attractive for international investors,
with average annual inflows of EUR 2.5bn, or 2% of GDP.
Further diversification of the investor base in the Romanian

economy towards North America and Asia could reduce
Romanias vulnerability to sudden stops in foreign capital
inflows in any future economic crisis. Liberalization of the
agricultural land market, along with strict requirements on the
practical experience of foreign investors in the area, could be
an attractive selling point for Romania in its quest for new
investors ready to enter the market. A skilled labor force in
engineering and medical services are other strong arguments
for locating new foreign direct investments in geographical
areas that currently lack the proper physical infrastructure, such
as the eastern and southern regions of Romania.
FDI per capita time gap between On the other hand, as our forecasts in the graph show, we
countries to increase believe that Romania is unlikely to be able to keep pace with
historical FDI developments in Poland, meaning that the time
lag might increase. There are a number of reasons for that:
a) in the years to come, capital is likely to remain much

more scarce and selective than in the past
b) the lack of proper road infrastructure is likely to make
foreign capital more interested in producing and
exporting services than industrial goods, with the
former being less capital intensive
c) in a European environment dominated by sluggish
25 June 2014
demand, by existing spare capacities and by pressures
from politicians to create additional jobs in home
countries and not abroad, Romania is in a challenging
position in terms of attracting new FDI
FDI boosted export per capita in both countries
Romanias exports of goods per Exports per capita of goods and services are two statistics
capita time lag rose from four to strongly connected to the level of foreign direct investments and
seven years to governments readiness to follow pro-market policies. As the
graph shows, Romanias export of goods per capita moved
from a four-year to a seven-year time lag, which again raises
questions about the destination of FDI and its contribution to
Romanias competitiveness as compared to Poland.
Chart 7: Exports of goods per capita (EUR)
2000
2002
2004
2006
2008
2010
2012
5,000 5,000
4,000 PL upper 4,000

7-year time lag
scale
3,000 3,000
2,000 2,000
1,000 RO lower 1,000

scale
0 0
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
Foreign direct investment companies accounted for 70.3% of

exports and 62.6% of imports in 2012, according to a joint study
by the central bank and statistics office. The trade balance of
foreign direct investment companies was still negative (-EUR
2.5bn), but this was primarily driven by high imports in the trade
sector, a commonplace occurrence because of the nature of
the activity in this area. The trade surplus in manufacturing
companies established through foreign direct investments was
solid, at EUR 3.9bn.
During 2013, exports played key role in In 2013, Romania was the second-fastest growing EU country
making Romania second-fastest and exports played a key role in its recovery, adding 4.4pp to
growing economy in EU total growth of 3.5%. Very good performance of Romanian
exports in 2013 was driven by structural changes that are likely
to persist in 2014 and beyond (production starts in new
factories in manufacturing that benefitted from high FDI in the
past, export market diversification outside the EU), and also by
transitory factors (outstanding agricultural harvest).

25 June 2014
After growing by 10% in 2013, annual exports of goods could
Forecast growth of 5-7% per year lose speed to 5-7% in 2014-20, a decent pace for keeping the
unlikely to make Romanias exports of trade balance under control even against a rise in imports, but
goods per capita catch up with Poland still insufficient for a successful catching up with Poland.
Chart 8: Exports of services per capita (EUR)
1996
1998
2000
2002
2004
2006
2008
2010
2012
800 800
700 PL upper 700

6-year time lag scale
600 600
500 500
400 400
300 300
200 200
RO lower
100 scale 100
0 1996 0
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
Exports of services per capita could Exports of services could rise faster than exports of goods in
increase faster, catching up with future and it is likely that here Romania could catch up with
Poland Poland sooner than in other areas. During the last year, the
Romanian government issued state aid schemes for financing
eleven major projects in IT&C and engineering services, both
greenfield projects and expansion of current businesses, which
would employ more than 4,000 people in the future. With
interest of foreign investors in the IT&C sector on the rise in big
university centers (Bucharest, Cluj, Iasi, Brasov, Timisoara), we
see incipient signs of a gradual shift towards an information-
based economy by 2020-30.
Poland has proved that EU funds absorption is key for

accelerating growth
Romanias absorption rate of EU Poor absorption of EU funds since 2007 has been a major
funds almost half that of Poland drawback for the development of the Romanian economy, both
during the crisis and the recovery. Poland currently has an
absorption rate of EU structural and cohesion funds earmarked
for 2007-13 of close to 70%, well above Romania, which
managed to absorb 45% of EU funds, if pre-financing and
payments are included; if only payments from the EU are
considered, then the absorption rate is only 35%. Poland
comes eighth in the EU28 in terms of using European money
for economic growth, while Romania is next to last in the EU,
surpassing only Croatia, the most recent member of the EU.
Statistics suggest that corruption Corruption and quality of institutions weighed heavily on
and quality of institutions weigh on Romanias capacity to absorb EU funds in recent years. The
EU funds absorption corruption index released by Transparency International in
2013 ranks Romania at position 69 out of 175 countries, with a
score of 43 points, which is just the average score of the 175
worldwide countries classified in the survey. Poland is in 38th
place, with a score of 60 points.

25 June 2014
Chart 9: Corruption index and absorption of EU funds in
CEE countries
100
Lithuania
Absorbtion Rate of EU funds

(from 2007-2013 allocations)
90
80 Latvia
Estonia
70 Czech R Poland
60 Hungary Slovenia
50
Slovakia
40
Romania R = 0.8535
30
20
10
0
40 45 50 55 60 65 70
Corruption Index (Transparency International, 2013)
Source: Erste Group Research, Transparency International, EU
The quality of institutions, as presented in The Global

Competitiveness Report 2013-14 of the World Economic
Forum, is another weak point for Romanias competitiveness
and growth. Romania ranks 114 out of 148 countries, far from
Poland (62nd place), with public institutions being one of the
most problematic factors for doing business. Romania should
try to make the most out of its status as an EU member in
making public institutions more business friendly, while
continuing the reforms agreed with the World Bank.
Chart 10: Quality of institutions and absorption of EU

funds in CEE countries
100
90 Lithuania
Absorbtion Rate of EU funds
(from 2007-2013 allocations)
80 Estonia
70
Hungary Poland Latvia
60 Slovakia Slovenia
50 Czech R
40 Romania
30 R = 0.8411
20
10
0
3.0 3.5 4.0 4.5 5.0
Quality of Public Institutions (WEF 2013-2014, score)
Source: Erste Group Research, World Economic Forum, EU
Low wages reflect economic and education system

rigidities
Average net wage in Romania 13 A successful transition towards a high-tech economy is key to a
years behind Poland rise in wages in the next 10 years. The Romanian labor market
is in stark contrast with Poland and the progress made so far is
too slow to lead to visible and long-lasting improvements in
population living standards. The average gross nominal wage in
Romania is at roughly the same level as in Poland 13 years
ago, while labor productivity shows a 12-year gap in favor of
Poland. Polands superior economic growth performance in

25 June 2014
recent years translated into a strengthening of the labor market,
with real wages growing by a cumulative 7% between 2009 and
2013. Romania was at the opposite side of the scale and
cumulated real wage growth was negative at -2.7% during the
last five years.
Current economic and education Annual nominal wage growth in the region of 4% in future years
circumstances could lead to is clearly not enough for Romania to narrow the huge gap to
increasing wage gap Poland in terms of employee income. At present, labor market
improvements are visible only in a small decline in the
unemployment rate and a rise in the number of new jobs
created in the economy, while wage growth remains
disappointing. Romania would need several years in a row with
economic growth of above 3% and broad improvement in levels
of education and qualification for a gradual acceleration of
wages in the private sector. On top of this, economic growth
should be located in those services which rely more on labor
and less on capital for a sustainable rise in pay in the
Romanian economy.
Chart 11: Average gross nominal wage (EUR)
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
1000 1000
PL upper
800 800
600 600
400 400
RO lower
200 scale 200
0 0
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
Source: local statistical offices, BCR Research 2019
Romania should no longer compete If Romania continues to position itself as a cheap labor force
on labor costs, but on labor quality destination on the international level, it will lose competitiveness
at the expense of Asian and African countries and will maintain
economic growth in the region of 2-3% per year, which is
clearly not enough for successful convergence with the
Eurozone. Currently, Romania invests only 0.5% of GDP in
research and development activities (equally split between
public and private sector), while Poland allots 0.9% of GDP for
these activities. Romanias target for 2020, in the context of the
Europe 2020 strategy for smart, sustainable and inclusive
growth, is 2% of GDP, while Poland should increase its
spending on R&D to 1.7% of GDP during the same timeframe.
With a single major project in research currently financed
through European structural funds (Extreme Light Infrastructure
Nuclear Physics), the low commercial relevance of academic
research and insufficient research activities of foreign
companies with a local presence, Romania should strive more
to attract new investments in high-tech sectors.

25 June 2014
Education reform should make Improving the quality and equity of the education system is key
system more oriented towards for boosting labor productivity in the Romanian economy by
business sector unleashing the important labor reservoir in rural areas.
Chart 12: Employment in agriculture (% of total

employment)
1996
1998
2000
2002
2004
2006
2008
2010
2012
50 50
40 40
30 RO lower scale 30
PL upper scale
20 20
12 years+ time lag

10 10
0 0
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
Romania spends the least amount of public money on

education in the CEE region (3.1% of GDP in 2011 according to
Eurostat), well below Poland which allotted 4.9% of GDP.
Private investments in education were also extremely low in
Romania, with 0.1% of GDP in 2011, seven times lower than in
Poland.
The results of the 2012 OECD Program for International

Student Assessment (PISA) show that Poland is better placed
than Romania in terms of what students know and are able to
do. Polish students scored better than the OECD average both
in mathematics, reading and science, while the performance of
the Romanian students was poorer.
Poland is also better placed than Romania in terms of the

business relevance of university studies, with two Polish
universities in the world top 500, as compiled by the business
education and networking company QS. No Romanian
university is present in the list. Youth unemployment declined to
27.3% in Poland in 2013, from levels close to 40% in early
2000, when education reform was implemented, while Romania
has experienced a continuing weakening trend, with
unemployment among young people rising to 23.6% in 2013
from 17.2% in 2000.
and, given the delayed impact on Even assuming that Romania follows an ambitious reform in
the labor market, should start education similar to those carried out by Poland back in 1999, it
immediately would still need at least ten years to reap the benefits on the
labor market. Higher wages as a result of improved labor
productivity, more people from rural areas entering the labor
market after graduating vocational schools and improved
scores in international school tests should be Romanias main
objectives for successful reform of the education system.

25 June 2014
The small number of employees relative to total population and

associated economic and social weaknesses derived from this
(1.2 pensioners for each employee) is a major challenge for the
Romanian labor market in the years ahead. With a population
of 20 million inhabitants, Romania has 4.4 million employees.
Even more worrisome, Romania has never exceeded 4.8
million employees, even during the economic boom period of
2007-08. Poland has 10 million employees and a population of
38.5 million inhabitants. Percentage-wise, 22% of Romanias
population works and receives a salary for its work, compared
to 26% in Poland.
Eurostat data shows that only one in seventy Romanians

between 15 and 64 years is currently employed under a
temporary work contract, compared to one in four Poles.
Boosting temporary work through a balanced mix of tax
incentives and decisive steps against illegal employment could
be an intermediary step in a long process of increasing the
number of employees in rural area. Strong employment in
subsistence agriculture (1/3 of total employment in Romania as
compared to 1/8 in Poland) keeps Romanias total labor
productivity at less than half the EU average, while Poland has
reached almost 60%.
Chart 13: Labor productivity relative to EU average

(EU=100%)
1999
2001
2003
2005
2007
2009
2011
60 60
55 PL upper 55
50 50
45 45
40 40
35 35
30 30
RO lower
25 scale 25
20 20
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
2021
2023
Similarly low inflations figures
Romania moved into single-digit Polands experience in combating inflation was used by the
inflation range six years after Romanian central bank during the process of adopting an
Poland inflation-targeting regime. Taking advantage of faster
disinflation, Poland adopted an inflation-targeting regime in
1998, seven years before Romania.
In November 1998, Polish inflation decreased to single-digit

territory after a sustainable disinflation process bolstered by
ambitious reforms like the withdrawal of state subsidies and
removal of price controls. At that point, Romanian inflation was
close to 40% and continued to place a serious burden on
entrepreneurs and households, both through its high level and
through its unpredictable evolution.
25 June 2014
Chart 14: Annual inflation rate (%)

20
18
16 RO PL
14
12
10
8
6
4
2
0
Dec-02
Jun-03
Dec-03
Jun-04
Dec-04
Jun-05
Dec-05
Jun-06
Dec-06
Jun-07
Dec-07
Jun-08
Dec-08
Jun-09
Dec-09
Jun-10
Dec-10
Jun-11
Dec-11
Jun-12
Dec-12
Jun-13
Dec-13
The slower restructuring of the Romanian economy made the

entire process of cutting the inflation rate to below 10%
considerably longer. Romania finally succeeded in bringing the
inflation rate into single-digit territory in November 2004, six
years after Poland.
Inflation volatility higher in Romania The disinflation process that followed was uneven, with
than in Poland frequent spikes in consumer prices, caused mainly by supply-
side shocks like poor agricultural crops, increases of global oil
prices and hikes in consumer taxes (VAT and excises). The
chronic imbalance between the supply of local products on
consumer market and demand persisted, with high imports of
processed food being just an example. The high share of
imported products made inflation more volatile, as it was
influenced by external prices on the one hand and by the
EURRON rate on the other.
Subdued inflation should allow The more recent decline of the inflation rate below the NBRs
Romania to bring bank minimum target corridor brings us to an unprecedented situation for a
reserve requirements closer to country that suffered from chronic inflationary pressures in the
those in Poland past the threat of too low inflation. May 2014 was the fifth
month in a row when inflation, at 1%, ran below the NBRs
corridor. Adjusted CORE2 inflation, a preferred measure of
inflation used by the NBR when calibrating its monetary policy
and calculated as headline inflation minus administered prices,
volatile prices, tobacco and alcohol has been negative since
October 2013. Under these circumstances, a looser monetary
policy through fresh cuts in minimum reserves would be
suitable for the current weakness of investments which are
pressured both by insufficient public funding of infrastructure
and deleveraging on the foreign currency side of corporate
loans. With minimum reserves at 12% for RON and 18% for
foreign currency, Romania remains far away from Poland,
which has a level of reserves of only 3.5% both for zloty and
foreign currency deposits. Back in 1999, in a move to
encourage lending in local currency, Poland abruptly reduced
the level of reserves for zloty deposits, from 20% to 5%.

25 June 2014
but different monetary policies
Tolerated euroization of Romanian Historically, although both central banks claimed to target
prices made NBR more focused than inflation, the Romanian central bank proved to be keener than
NBP on fx stability the Polish one to provide a much less volatile exchange rate.
This is because the fx rate in Romania has been seen as a
stronger tool to contain inflation than the interest rate. For this
reason, the euroization of the economy was silently accepted in
Romania where many prices are denominated in euros for no
reason, a situation which is much less present in Poland. The
tacit official acceptance of the euroization is hard to reverse
these days and has at least two important consequences. On
the one hand, it takes the central banks monetary policy
hostage, as any monetary policy decision has to be taken with
an eye to the exchange rate, a situation which has forced the
NBR to delay rate cut decisions in the past. On the other hand,
the euroization is also putting pressure on Romania to join the
euro in order to formalize the whole situation and bring to an
end the conflicting objectives which NBR tries to accommodate
simultaneously. Poland, where the zloty remains the preferred
price denominator, can afford to postpone euro membership at
its discretion.
Chart 15: EURRON and EURPLN volatility

25%
PLN volatility RON volatility
20%
15%
10%
5%
0%
Dec-09
Mar-10
Jun-10
Sep-10
Dec-10
Mar-11
Jun-11
Sep-11
Dec-11
Mar-12
Jun-12
Sep-12
Dec-12
Mar-13
Jun-13
Sep-13
Dec-13
Mar-14
Source: Reuters, BCR Research
EURRON volatility half that of On average, during the past four years, the Polish zloty has
EURPLN, at cost of experienced volatilities twice as high as the Romanian leu, with
the benefit of more stable interest rates. In other words, the
NBR has preferred to sacrifice interest rate stability for the sake
of fx stability, while the NBP preferred to do the opposite,
providing a stronger relevance and anchor to the monetary
policy rate. The spread between money market rates and the
NBPs key rate rarely widened to 100bp and when it did, the
decoupling episode lasted for a very short period of time.

25 June 2014
Chart 16: 1W money market rate and key rate, Poland

(nominal, %)
15 %
1W WIBOR Key rate

12
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
Jun-11
Jun-12
Jun-13
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Source: NBP website, BCR Research
much more volatile interbank On the other hand, Romania experienced long periods of time
rates, occasionally decoupled from (five months and above) when money market rates decoupled
NBRs key rate from the NBRs key rate by more than 100bp. Except for quite a
long period in the second half of 2008 and early-2009 that
coincided with heightened stress on international financial
markets and when money market rates were significantly above
the key rate, in other decoupling episodes, money market rates
were below the key rate. Periods of excess liquidity thus implied
looser monetary policy than the key rate level signaled.
Chart 17: 1W money market rate and key rate, Romania

(nominal, %)
15
%
1W ROBOR Key rate

12
0
Dec-05
Jun-06
Dec-06
Jun-07
Dec-07
Jun-08
Dec-08
Jun-09
Dec-09
Jun-10
Dec-10
Jun-11
Dec-11
Jun-12
Dec-12
Jun-13
Dec-13
Source: NBR, BCR Research
Frequent decoupling episodes of The high profile of fx loans in total non-government loans
money market rates from key rate (above 50% since August 2007) and wide interest rate corridor
affected confidence in local around the key rate for lending facility and deposit facility
currency loans (400bp before May 2013 and 300bp since then) weakened
the monetary policy transmission mechanism in Romania. The
imperfect functioning of local fixed income and equity markets,
which lacked liquid and also long-term investment instruments
for a long time, compounded the weak link between monetary
policy instruments and domestic demand. In turn, this affected
households and companies propensity to take out loans in the

25 June 2014
local currency, due to lack of predictability of future interest
rates in the local currency coupled with the implied promise of
stable and predictable fx rates.
More volatile real key rate suggests An analysis of real rates reveals that, although 1W real money
that NBR was slower than NBP in its market rates were similar on average during the last eight
monetary policy responses years, the Romanian one was more volatile. A more volatile
real key rate might suggest that the NBR was slower in its
monetary policy responses, raising rates or cutting rates later
than the inflation outlook might have requested. The decoupling
of the interbank rates and the higher volatility is again obvious
in Romanias case.
Chart 18: 1W money market rate and key rate, Poland

(real, %)
8
%
Real key rate
6
Real 1W money market rate
4
-2
-4
-6
Dec-05
Jun-06
Dec-06
Jun-07
Dec-07
Jun-08
Dec-08
Jun-09
Dec-09
Jun-10
Dec-10
Jun-11
Dec-11
Jun-12
Dec-12
Jun-13
Dec-13
Source: NBP website, BCR Research
Chart 19: 1W money market rate and key rate, Romania

(real, %)
8
%
Real key rate
6
Real 1W money market rate
4
-2
-4
-6
Dec-05
Jun-06
Dec-06
Jun-07
Dec-07
Jun-08
Dec-08
Jun-09
Dec-09
Jun-10
Dec-10
Jun-11
Dec-11
Jun-12
Dec-12
Jun-13
Dec-13
Source: NBR, BCR Research
Looking forward, a shift in the NBRs monetary strategy towards

that followed by the NBP might now be needed. But the
excessive focus on the fx rate on the part of the public and
public institutions is likely to make any strategy shift more
difficult. On the other hand, any further implementation of a
strictly managed floating fx regime poses a threat to Romanias
economic recovery. Low and predictable money market interest
rates are of paramount importance at present, in the context of
a shift of non-government lending from the fx component to the
25 June 2014
local currency component. At the same time, keeping the
EURRON rate artificially stable would continue to make clients
overlook the fx risk and the interest rate risk associated with a
hiking cycle of the FED and of the ECB in the next years.
Yield curve developments show that investors believe in

Romanias convergence story
Romanian yields at mid and long The evolution of yields for local currency government bonds is
end of the yield curve (five to ten yet further evidence that the presence of foreign investors,
years), almost on par with Polish coupled with political stability, is a key ingredient that could
yields in 2012 facilitate the rapid narrowing of the development gap between
Poland and Romania. In 2014, Romanian yields at the mid and
long end of the yield curve (five to ten years) were almost on
par with Polish yields in 2012. This is true both when
considering nominal yields and the spread to German bunds,
while an analysis of real yields shows a gap of only one year.
Government borrowing costs one of In recent years, Romania implemented a harsher fiscal
very few areas where Romania consolidation program compared to Poland, which enabled it to
managed to narrow gap to Poland in post better looking figures for headline and structural budget
recent years deficit according to the European Commissions Spring 2014
Economic Forecast. The level of the governments borrowing
costs is one of the very few areas where Romania has
managed to narrow the gap to Poland in recent years,
suggesting that the convergence story is valid if adequate
public policies are followed and the external environment is
supportive. Another implication is that the current room for an
additional rally of local currency yields is limited in Romania.
Put another way, Romania should improve the real
convergence indicators previously discussed, convince
investors of its strengthened capacity to repay public debt in the
future and only then look for significantly lower and stable bond
yields.
Chart 20: Local currency yield curve
9% Romania Poland 9%
2010
2012
6% 2010 6%
2012
2014
3% 2014 3%
0% 0%
1Y 3Y 5Y 10Y 1Y 3Y 5Y 10Y
Source: Reuters, BCR Research
Banking sector reflects economic discrepancies

Both Romanian and Polish banking
The Romanian and Polish banking sectors resemble each other
systems have strong foreign
in many respects. Both are integrated with the Eurozones
presence and are currently
banking sector, with a particularly high presence of foreign
changing their business models
25 June 2014
capital in Romania, where 90% of banking assets are owned by
investors from outside the country, while in Poland the share is
close to 70%. Both banking sectors are currently readjusting
their business models towards lending in local currency rather
than in fx and are more oriented towards funding their activity
through deposits attracted on local markets.
Chart 21: Share of non-government loans in GDP

60%
RO PL
50%
40%
30%
20%
10%
0%
2006 2009 2013
Source: ECB, BCR Research
Further consolidation is possible in both banking sectors, as the

outcome of the comprehensive stress tests currently performed
at the European level and the need for economies of scale in
securing adequate profitability create favorable environment for
M&A. This is especially true in the case of Romania, where 40
banks, most of them universal, operate in a market with single-
digit growth of business and which lacks deep specialization on
certain segments. Banking the unbanked population in rural
areas remains an important growth pocket for the long-run, but
strong and sustainable real GDP growth rates are needed
before that.
Financial intermediation shows Financial intermediation calculated as share of non-government

seven-year gap between Romania loans in GDP shows a seven year gap between Romania and
and Poland Poland. Part of the gap is due to the number of bank
bankruptcies which occurred in the late 90s and forced part of
the banking assets to be written off. Romanias rapid economic
growth during 2000-08 was fuelled by bank loans and foreign
direct investments, two areas where Romania managed to
reduce the gap to Poland rather rapidly, because it depended
more on global investor sentiment and less on public policies.
On the other hand, households and non-financial company

deposit growth was slower than loans before 2009. The
situation has changed since then and rising prudence has
made households more inclined to save money, while some
cash-rich companies found bank deposits more attractive than
new investment projects, which were perceived as scarce and
risky. However, comparative deposit growth was not fast
enough and Romania remains more than ten years behind
Poland in terms of non-government deposits in GDP.

25 June 2014
Chart 22: Share of non-government deposits in GDP

60%
RO PL
50%
40%
30%
20%
10%
0%
2004 2009 2013
Low wages and no banking penetration As shown in the graph below, household deposits per capita
in rural areas affects saving behavior replicate these statistics, with Romania 2013 being almost on
par with Poland 2004 even after adjusting for wage differences.
Low level of wages and almost no banking penetration in rural
areas are two elements that explain the depressed saving
behavior of the population in Romania. At the same time, prior
to the economic recession, Romanians displayed a natural
tendency towards consumption at the expense of saving, which
is still visible in the stock of consumer loans (rather high) and
deposits (quite low).
Chart 23: Household deposits per capita

4000 Households' deposits Households' deposits per 5.0
per capita (EUR) capita relative to wages
4.0
3000
3.0
2000
2.0
1000
1.0
0 0.0
2004 2009 2013 2004 2009 2013
RO PL RO PL
Corporate lending relative to GDP A comparative look in the chart below at loans to non-financial
ratios at similar levels in both corporations in Romania and Poland (expressed as share of
countries, which means that GDP) reveals that Romania is very close to Poland and
additional growth of lending on this segment needs additional
nominal GDP growth. With corporate lending rather subdued,
economic growth could be financed through EU funds, better
collection of tax revenues to the state budget or through private
investments based on cash accumulation in the past, corporate
bond issuance or company listings on stock exchanges. Since
employment is expected to be less supportive for future growth,
potential GDP could receive a major boost from improved
25 June 2014
productivity in agriculture, energy or public transportation
companies. A vicious circle between corporate lending and
economic growth could turn thus into a virtuous circle, with
economic growth facilitating corporate lending and corporate
loans generating economic growth.
Chart 24: Share of loans to non-financial corporations

(% of GDP)
20%
RO PL
15%
10%
5%
0%
2004 2008 2013
corporate loans should rise hand- In spite of economic recession and consequent slow recovery,
in-hand only with nominal GDP some of those companies with local presence are cash rich
growth and, therefore, hardly need new bank loans. Cash-rich
companies are also some of the best rated companies, which
make them able to qualify easily for alternative funding sources
corporate bond issuance and listing on stock exchanges.
Corporate lending remains a cornerstone of the development of
the local banking sector in future years, but banks should seek
more actively fresh growth drivers on the corporate segment,
like assisting corporate clients in raising capital on financial
markets, involvement in M&A transactions, offering new
investment products for cash rich companies and improving
their offer for SMEs.
Romania relied twice as much as The Romanian banking sector relied more on fx lending in the
Poland on fx loans past, which was not unusual, given the high nominal interest
rates in the local currency and lack of predictability in their
evolution. Share of fx loans in total non-government loans
exceeded the 50% threshold in mid-2007, when lending was
booming. It came very close to 65% in 2010 and 2011, before
declining to below 60% at the beginning of 2014. In Poland, the
share of fx loans has never exceeded 37% and has recently
declined to below 30% as a consequence of a lower and
predictable local currency interest rate environment.
although enjoying similar off- Growth of fx lending in Romania before the onset of the global
shore funds inflows economic crisis was driven by the same underlying factors as in
Poland. On the supply side, fx loans were supported by the
growing presence of foreign banks on the local market and the
associated increased competition. The low interest rate
environment in developed European economies and abundant
liquidity made foreign banks look for attractive returns in the
Romanian economy. Demand was sustained by the high
interest rate differential between the local currency loans and fx
loans and overly optimistic perception of future economic
developments by consumers and companies, which made them
25 June 2014
overlook the fx risk.
Things have started to change in recent quarters, both on the
During post-crisis years, local supply and the demand side, and loans in the local currency
currency loans preferred product have gained more speed. On the supply side, comprehensive
pushed by banks stress tests currently in progress in the European banking
sector (with final results due in the autumn of 2014) put a brake
on banks willingness to increase their fx exposure on the local
market. Interest rates for new euro loans in Romania moved
closer to those from the Eurozone, making the local market less
attractive for euro loans. ECB data shows that the average
interest rate for a new euro mortgage loan in Romania was
5.1% in 2013 (1.8pp above Eurozone average), while in 2007 it
was 8% (2.8pp above Eurozone average). And last but not
least, fx liquidity in banking sector is not as ample as in the pre-
recession period.
On the demand side, interest rate convergence between loans

in RON and fx on the local market made clients less willing to
take exposure to the fx risk. In the first quarter of 2014,
Romanian clients were charged 0.1pp less for a new mortgage
loan in RON as compared to one in euro. Four years ago, they
were charged 7.2pp more for a new mortgage loan in RON as
compared to one in euro in a period of intense stress on
financial markets which amplified interest rate fluctuations and
made their future level very hard to predict.
Chart 25: Households loans per capita (EUR)

4,000
RO PL
3,000
2,000
1,000
0
2006 2010 2013
Household loans per capita show Household loans per capita show that Romania maintains a
Romania seven years behind Poland seven-year development gap to Poland. A breakdown of
consumer and mortgage loans reveals that consumer loans per
capita in Romania are much closer to those in Poland, while in
the case of mortgage loans, Romania has a long way to go to
reach Polands levels. Romanians were particularly keen to
take out consumer loans in the economic boom years, with a
tendency towards fx loans due to the previously mentioned
reasons. Mortgage loans were extended almost entirely in
euros and to a much lesser extent in Swiss francs, while
lending in the local currency was almost nonexistent.
Mortgage loans seem to have Mortgage loans thus have more space for future growth in
much more upside potential Romania and the recent shift of lending towards the local
than currency component is a step in the right direction. If residential
prices advance strictly in line with the populations disposable

25 June 2014
income and interest rates remain low and above all predictable,
we think that lending for house purchases has a good chance
of converging with Polands level in seven to ten years.
Chart 26: Mortgage loans per capita

2400 Mortgage loans per Motgage loans per capita 3.0
capita (EUR) relative to wages
2000 2.5
1600 2.0
indebtedness
1200 1.5
degree
higher
800 1.0
400 0.5
0 0.0
2004 2008 2013 2004 2008 2013
RO PL RO PL
Source: BCR Research calculation based on ECB and Eurostat
consumer loans which show On the other hand, consumer loans need additional growth of
Romanians as more indebted on wage the populations disposable income for sustainable increases in
1
adjusted basis the future. The indebtedness degree , calculated as the ratio
between consumer loans per capita and monthly wages, is
higher in Romania than in Poland. Since 2007, Romania and
Poland have experienced different trends with respect to
consumer loans Romanians reduced their indebtedness by
repaying consumer loans taken in economic boom years, while
Poles added new consumer loans.
Chart 27: Consumer loans per capita

1000 Consumer loans per Consumer loans per 2.0
capita (EUR) capita relative to wages
higher indebtedness
800
1.5
600
1.0
degree
400
0.5
200
0 0.0
2004 2008 2013 2004 2008 2013
RO PL RO PL
Source: BCR Research calculation based on ECB and Eurostat data
1
This measure of indebtedness degree is the number of months needed by a person to repay his or her consumer loans,
supposing that person earns the average wage of the economy and all persons in the economy have a consumer loan.
Although the latter condition is strong, the indicator should be interpreted in evolution over time and when benchmarking one
country against other.
25 June 2014
The same indebtedness statistic used in the case of mortgage
Mortgage loans have more room to loans shows that mortgage loans are favored by the
grow than consumer loans considerably lower indebtedness degree of Romanians in
relation to Poles. In recent years, Romanians added new
mortgage loans to their holdings (opposite behavior compared
to consumer loans), but they are still far behind Polish clients.
Further development of mortgage loans could support saving

behavior among individuals looking to buy a house in the future,
because all banks require a down payment before approving a
loan. Romania would then be in a position to narrow the gap to
Poland both in terms of households deposits and mortgage
loans, with an important role played by long-term saving
instruments that would help the development of local financial
markets and would reduce the maturity mismatch in the local
currency.
Conclusions
The analysis performed in this report suggests that, in terms of

most economic and banking indicators, Romania shows a time
lag in excess of six years, going as high as 12-13 years for
nominal wages or employment in agriculture. This is mainly the
result of the different appetite for reform shown by the two
countries and by the fact that, despite the success model
offered by Poland, Romania preferred to take a different, more
conservative, approach to economic development.
With regard to the future, there is good news and bad news.
The good news is that Romanias convergence story is likely to
remain valid, following a similar development path with Poland.
The bad news is that, as time goes by, narrowing the gap might
prove challenging, since a number of opportunities have been
lost and the brands of the two countries have already been set
in stone. On the other hand, the lack of coherent public policies
aimed at increasing Romanias attractiveness for foreign and
local investors and boost EU funding raises the odds of an
increasing development gap. Last but not least, the educational
gap between the two countries and the significant time required
before any change in the education system is reflected in the
economy, suggests that, without immediate action in this area,
Romania risks being left even further behind.

25 June 2014
Table 1: Summary of development gap between Romania
and Poland
Indicator Time lag Outlook
Corporate loans in Almost no Corporate loans to grow in line with nominal GDP.
GDP lag
RON yield curve 2-year Gap could rise if fiscal policy does not remain
consistent and predictable.
FDI per capita 5-year Gap could increase because capital likely to
remain scarce and selective in coming years.
Exports of services 6-year Gap could narrow due to rising exports in IT and
per capita transportation services.
Consumer loans per 6-year Gap to persist in absence of stronger wage

capita growth.
GDP per capita 7-year Gap could remain unchanged in absence of higher
productivity in agriculture and the state-owned
companies, higher private and public investments.
Exports of goods per 7-year Gap could remain unchanged in absence of

capita additional foreign and domestic investments in
manufacturing.
Energy consumption 7-year Gap could remain unchanged as low energy

per GDP prices do not stimulate efficiency
Mortgage loans per 7-year+ Gap to narrow slowly due to recent decline of
capita RON interest rates to levels similar to EUR interest
rates and rising demand for quality houses
Households deposits 9-year+ Gap to narrow slowly due to precautionary

per capita reasons and stronger focus of banks to collect
deposits from local market
Labor productivity 12-year Gap to persist as educational reform remains slow
Employment in 12-year+ Gap could narrow very slowly due to higher private
agriculture investments and EU funds inflows in agriculture in
recent years
Nominal wages 13-year Gap to persist in absence of any qualitative

change in GDP structure towards high value
added sectors backed by more educated workers

25 June 2014
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M. Grkem Gker (Equity) +90 212 371 2534 Christopher Lampe-Traupe +49 (0)30 8105800 5507
Sezai Saklaroglu (Equity) +90 212 371 2533
Nilufer Sezgin (Fixed income) +90 212 371 2536
Ilknur Unsal (Equity) +90 212 371 2531

25 June 2014
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2014-06-25 Poland - Reading Romanias Newspapers of Tomorrow

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2014-06-25 Poland - Reading Romanias Newspapers of Tomorrow

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Erste Group Research

Special Report | Fixed Income | Romania

Special Report: Romania

Poland - Reading Romanias Newspapers of Tomorrow?

A tale of two similar countries

Despite the similar demographic, geographic and economic

Long-standing economic development gap

Chart 1: Comparative real GDP dynamics (1989 = 100%)

Source: Eurostat, IMF, BCR Research

Many economic, political and social events have shaped

Erste Group Research Special Report Page 2

During 2009-12 the gap increased even further as, while

Chart 2: Structural budget deficits (% of GDP)

2006 2007 2008

Looking forward, under current conditions, Romanias annual

Chart 3: GDP per capita at purchasing power parity

Source: Eurostat, IMF, BCR Research

Romania to move to less energy intensive economy

The delayed liberalization of energy prices or lack of any

Erste Group Research Special Report Page 4

Chart 4: Energy intensity of the economy expressed as

200 2001 200

Erste Group Research Special Report Page 5

Chart 5: Gross value added in total economy vs. gross

160% Gross value added in energy

The presence of foreign capital in the economy is one of the

Both countries have enjoyed strong FDI inflows

Erste Group Research Special Report Page 6

Chart 6: Stock of foreign direct investments per capita

4,000 PL upper 4,000

Further diversification of the investor base in the Romanian

a) in the years to come, capital is likely to remain much

FDI boosted export per capita in both countries

Chart 7: Exports of goods per capita (EUR)

4,000 PL upper 4,000

1,000 RO lower 1,000

Foreign direct investment companies accounted for 70.3% of

Erste Group Research Special Report Page 8

Chart 8: Exports of services per capita (EUR)

700 PL upper 700

Poland has proved that EU funds absorption is key for

Erste Group Research Special Report Page 9

Absorbtion Rate of EU funds

Source: Erste Group Research, Transparency International, EU

The quality of institutions, as presented in The Global

Chart 10: Quality of institutions and absorption of EU

Low wages reflect economic and education system

Erste Group Research Special Report Page 10

Chart 11: Average gross nominal wage (EUR)

Erste Group Research Special Report Page 11

Chart 12: Employment in agriculture (% of total

12 years+ time lag

Romania spends the least amount of public money on

The results of the 2012 OECD Program for International

Poland is also better placed than Romania in terms of the

Erste Group Research Special Report Page 12

The small number of employees relative to total population and

Eurostat data shows that only one in seventy Romanians

Chart 13: Labor productivity relative to EU average

Source: Eurostat, BCR Research

Similarly low inflations figures

In November 1998, Polish inflation decreased to single-digit

Chart 14: Annual inflation rate (%)