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Economic Outlook
Spring Report
May 2011

Motto: Be not afraid of going slowly, be afraid only of standing still Sun Tzu

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Table of Contents

I. II.

Executive summary 3 Macroeconomic Outlook 6

II.1. External assumptions Supply-side inflation triggered monetary tightening in EU 6 II.2.Gross Domestic Product Signs of recovery 8 II.3. Inflation Upside risks to the disinflation process 12 II.4 External Sector Running above expectations 14 II.5. Fiscal Policy and Public Debt Following the austerity flow 18 II.6. Labor Market The new labor code: A step forward? 21 III. Financial Market 22

III.1. Monetary policy Caught between a rock and hard place 22 III.2. Money Market and Government Bonds Consolidating the domestic secondary market 24 III.3. Forex Market More bullish perspectives long-term 27 III.4. The Capital Market Still running to catch-up 29 III.5.Banking sector Seeking profits in a low borrowing appetite environment 34 IV. Forecast: Main Macroeconomic Indicators 37

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I. Executive summary
Gross Domestic Product: Signs of recovery. We expect the Romanian
economy to rebound moderately at 1.5% in 2011, after a contraction of 1.3% last year. In 2012, we anticipate the recovery to pick up at 3.0% as domestic consumption returns to positive growth, while industry and external demand remain supportive. The growth-restrictive effects of fiscal tightening measures taken in 2010 to consolidate the fiscal deficit will gradually ease.

Inflation: Upside risks to the disinflation process. Inflation surged to

8.0% in Mar11, as the headline figure incorporates the base effect of the VAT rate hike to 24% in Jul10, as well as recent supply-side pressures coming from dynamics in food, fuel and administrated prices. We expect the inflation rate to drop sharply (although less than initially anticipated) to 4.9% at the end of 2010, once the unfavorable base effect is over, given the absence of demand-led inflationary pressures, as shown by CORE2 persistently much lower than headline inflation. However, there are growing risks coming from external market evolution of oil, agricultural commodities prices in addition to liberalization of administrated prices on the domestic market. For 2012, we expect inflation to remain within NBR target interval and look for a figure of 3.5% at the end of the year.

External sector: Running above expectations. The external sector

outperformed our expectations in 2010, as the Current Account deficit remained virtually flat in nominal terms (EUR 5.0 bln), while the Trade Gap narrowed further, driven by extremely strong export evolution and a relative stabilization in net transfers. For the medium-term, we believe Trade Gap will resume widening in nominal terms, as the anticipated recovery in domestic demand should prompt imports growth rate to catch up with that of Exports. For the Current Account Deficit, we expect it to hover at moderate levels below 5.0% of GDP, normal for a catching-up economy during the convergence process.

Fiscal policy and public debt: Following the austerity flow. After the
government achieved the budget deficit target of 6.8% of GDP, it targets further fiscal consolidation to bring the deficit down to 4.4% of GDP this year and to 3.0% of GDP in 2012. The recently adopted laws which aim at structural reforms are potentially beneficial for the long-term sustainability of public finances, but it is likely that their short-term effect will not be sufficient to reach this years target. Thus, the government will continue focusing on reducing personnel and capital expenses, but we believe improving tax collection and reducing fiscal evasion are absolutely mandatory to achieve medium-term sustainability.

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Unemployment: The new labor code A step forward? The

unemployment rate fell to 5.9% in Mar11, after reversing in Apr10 the previous deteriorating trend. Nevertheless, employment figures and average net wage continue falling, showing that labor market conditions remain loose. The unemployment trend primarily reflects the lack of flexibility in the labor market. The changes made to the labor code aim at correcting exactly these faults, but its degree of success remains to be seen. Overall, we anticipate unemployment to rise to 7.5% in 2011, before moderating to 7.0% in 2012 in line with the acceleration in economic recovery.

Monetary policy: Caught between a rock and hard place.


inflation surging due to VAT hike and rising supply-side pressures, there is virtually no room for NBR to resume the easing cycle at least until Q311 when disinflation in expected to set in firmly. Considering the large output gap and weak domestic demand, we believe there is potential for rate cuts up to 50 bps this year, if inflationary pressures coming from supply factors subside and second-round effects from VAT hike remain muted, in line with our baseline scenario.

Money market and Government bonds: Developing the secondary market. According to our calculations, the governments funding needs
amount to c. RON 86 bln in 2011, if we assume the target deficit of 4.4% is fulfilled. Thus far, the local context has been favorable as excess liquidity pushed money market ever lower, while the improved economic outlook and cheaper borrowing costs attracted demand from foreign investors, especially for shorter-maturities. The government already secured around RON 38 bln, and the announced issuance of an EMTN by the end of H111 should also prove supportive of yields.

Forex market: More bullish perspectives long-term.

We are more

positive on the RON for 2011, although we think the recent rally was too brisk and a technical correction will likely follow. Moreover, recent NBR comments mark a shift in language suggesting that the new comfort interval for EURRON changed from 4.1-4.3 to 4.0-4.2. Consequently, NBR is less likely to step in and curb recent appreciation, given the high inflation figures and improved macro fundamentals. Thus, we expect the EUR/RON to correct towards 4.15 at the end of H111, but could appreciate to 4.05 by the end of 2011, if fiscal consolidation is on the right track and economic growth resumes. For 2012, we estimate EURRON at 4.0 eop, if our main scenario materializes.

Capital market: Still running to catch up. We reiterate the significant

gap between our domestic stock exchange and the neighboring countries in terms of both liquidity and capitalization figures since our previous report,

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despite that Fondul Proprietatea (FP) technical listing at the end-January11 brought increasing liquidity and free-float for the Bucharest Stock Exchange. Still, we believe that this gap should be filled in once the Government plans to sell some its of stakes and/or privatize some state-owned companies via Bucharest Stock Exchange will materialize and large foreign institutional clients would appreciate as attractive Romanian stocks.

Banking sector: Seeking profits in a low borrowing appetite environment. The second year of economic contraction took its toll on
2010 banks business volumes and profitability, without weakening banks solvency. For 2011, we expect non-governmental loans to increase by 5.2% y/y (vs. +4.7% y/y in 2010), nominal terms, supported by corporate sector. The non-governmental loans growth should be higher at 10.8% y/y, nominal terms in 2012. On deposits side, we dont estimate any significant change in households savings pattern in 2011, whilst the corporate segment is expected to use all its resources for mediumlong term growth. Thus, we expect deposits to rise by 6.4% y/y, nominal terms, in 2011 and by 10% y/y, nominal terms for 2012. We anticipated provisions stock to increase by 21.8% y/y in 2011 (vs. 57.4% y/y in 2010), leading the coverage ratio to 57% in 2011 vs. 56% in 2010, mainly due to 1) higher pressure for provisions stemming from deterioration of loans classified currently as 60 days overdue; 2) reevaluation of guarantees at lower prices given the downward adjustments of assets prices. Thus, we expect a small profit for banking sector for 2011, whilst still some banks should end 2011 in the red.

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II. Macroeconomic Outlook II.1.

monetary tightening in EU

External assumptions Supply-side inflation triggered

The past year surge in exports driven by foreign demand and the impact on domestic inflation of surging oil and agricultural commodities on the international markets make it appropriate to introduce an overview of the main external assumptions used in our base case scenario. The forecasted variables and global outlook are the result of research from Societe Generale (SG). Based on the degree of influence on the Romanian economy, we have identified several key indicators to present in further detail. Since our previous report, oil and agricultural commodities prices surged. This evolution was transmitted relatively fast in domestic inflation, considering the structure of the CPI basket which gives a significant weight to food and oil products, exacerbated by seasonal effects. Indeed, bullish oil fundamentals including strong global demand (driven by Asia and especially China) and geopolitical risk caused by social tensions in Middle East/North Africa determined the Brent crude oil prices to break the range of $70-85/brl within which it traded since October 2009 and move to the higher range $90-110/brl. Moreover, non-fundamental factors like the low interest rate environment (with US likely to remain at record low) and high liquidity also supports the bullish oil outlook, with average Brent oil prices set estimated at $98/bbl in 2011 and $105/bbl in 2012. SG analysts also revised their EUR/USD forecast, now predicting more USD weakness going forward and a EUR/USD reaching 1.5 at the end of 2011. In terms of Euro area GDP growth, recovery rates are seen as moderate going forward, hit by higher commodities prices and fiscal adjustment measures. In 2010, Euro area expanded by 1.7% y/y driven mostly by Exports activity, which benefited from the recovery in global trade, with consumer demand somewhat hurt by the fiscal adjustment measures. In this context, Germany remained the Euro area driver, expanding by 3.5% y/y in 2010. Looking ahead, Germanys relatively balanced situation (except for the need to adjust a current account surplus) implies that it will continue enjoying growth above potential in the medium-term, since it will not be forced to step up the fiscal tightening measures. Overall, strong domestic demand is supportive of robust Exports evolution for Romania, given that most of our exports are geared towards Euro area, and specifically Germany. Looking at imported inflation coming from Euro area, we consider the upside risks of Euro area CPI are driven by supply-side pressures stemming from energy and food prices. SG economists expect core inflation to stagnate this

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year at around 1.0%, but headline inflation is bound to rise to 1.9% in 2011 from 1.6% last year. In terms of implications for the Romanian economy, we consider them a risk to our main scenario. Higher inflation also prompted the ECB to adopt a hawkish tone, and to start the tightening cycle at the beginning of April in order to tame rising inflationary pressures. ECB officials also pointed at moderately more positive outlook for economic recovery as a reason to normalize interest rates in the near future. Indeed, in line with market expectations, ECB hiked the refi rate by 25 bps and SG expects further rate increases for the refi rate to reach 2.0% at the end of 2011. Nevertheless, it is highly unlikely that this move will have a material impact on NBRs decisions to change the rate this year, considering the different growth picture in Romania.

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GDP growth: comparison, %, real change y/y


Gross Domestic Product Signs of recovery

Pl 3.2 2.8 3.1

4.2 3.9 3.8

CEE peers registered positive GDP growth in 2010 supported by strong export activity and reviving domestic demand, but Romanian economic recovery lagged behind, as the fiscal adjustment measures took their toll on growth. In 2010, GDP contracted by 1.3%, outperforming market consensus (-2.0% y/y), but closer to our expectations of -1.5% y/y. Exports registered




2.3 2.4


0.2 1.5 1.9 1.6 1.8 2 1.7 1.8 -2 0 2



a strong rebound in 2010 (+13.1% y/y vs. -5.5% y/y in 2009, real terms), but foreign demand alone was not enough to offset the contracting domestic demand, weakened further by the fiscal adjustment measures taken in Jul10. We anticipate domestic demand will recover gradually in H211, once the negative effect of the VAT hike and cut in public sector wages gradually fades. Meanwhile, exports are still expected to moderate slightly from the extremely strong growth rates in 2010. Demand Structure of GDP: y/y




Euro area


Source: Eurostat



Sources of GDP growth: y/y






-10.0% 2003 2004 2005 2006 2007 2008 2009 2010 2011f 2012f











Agriculture Net taxes on product

Industry Services

Construction GDP real growth %

Domestic consumption Inventories

Investments GDP real growth

Net exports

Source: NIS, BRD-GSG

Source: NIS, BRD-GSG

Industrial Output:
5.9 3.7 3.3 4.0 4.2 4.2 4.2 2.4 1.3 5.8

Overall, 2010 figures confirmed our expectations for a mixed picture in terms of sectors evolution, which we anticipate will continue throughout 2011. The Industrial sector continues to outperform other real economy sectors,

-0.7 -2.2 -3.5 -6.7 -11.1 1Q09 2Q09 3Q09 4Q09



being one of the main drivers of economic activity. It was the first sector to recover (+5.1% y/y in 2010), on the back of a revival in global trade which boosted foreign demand. As suggested by 2010 figures, this advance is driven not only by inventory rebuilding (intermediary goods increased by +9.2% in 2010), but also by Capital goods (+7.9% y/y in 2010). Moreover, remarkably strong Factory Orders (+26.3% y/y in 2010 and +33.1% y/y in 2M11) indicate that the Industrial sector dynamics will remain robust.

-9.3 4Q08

y/y, % change
1Q10 2Q10 3Q10 4Q10

Source: NIS, BRD-GSG

Retail, Tourism, Transport, Telecom:

5.5 1.3 -0.7 -4.8 -7.6 -3.4 -3.0 -3.4 -2.4 -0.5 -1.9 -4.2 -6.5 -11.8 -2.9

q/q y/y, %

Nevertheless, we anticipate Industrial growth to moderate and reach 3.0% y/y in 2011 and 2.8% y/y in 2012, as the favorable base effect from 2009 is over and potential for further inventory rebuilding gradually diminishes.

-11.9 -12.5 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10

Source: NIS, BRD-GSG

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60% Construction (y/y, %) 40% 20% -20 0% -30 -20% -40% -40 -50 Construction (12M rolling, %, y/y) Construction confidence 0 -10 10

Constructions shows marginal recovery (-10.7% y/y in 2010) compared to H110 (-12% y/y), and there are prospects for further rebound in 2011. Latest Constructions data (-4.7% y/y in Q111) and improving Fixed Capital Formation figures (-13.1% y/y in 2010 vs. -25.3% y/y in H110) support our view that this sector has the potential to stabilize in 2011. However, the subdued recovery in disposable income and high levels of household indebtedness imply that residential sector will remain the laggard (after plunging by 36.6% y/y in 2010), despite the First House 4 program.

Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10

Source: NIS, Eurostat, BRD-GSG


Meanwhile, reduction in fiscal expenditure meant Capital investments plunged in 2010 (-11.7% y/y). Given the need for infrastructure upgrades, we believe that there is potential for engineering works and repairs to help this sector reach stabilization in 2011 and grow at +5.0% in 2012, also depending on better absorption of EU funds.


y/y, % change
4.7 -0.1 0.6


-2.6 -5.4 -5.4 -6.3 -5.9 -8.3 -14.2


-17.4 -15.9

Services improved moderately in 2010 compared to the sharp contraction in 2009, but remained on negative ground. Retail and Other Services (mostly comprised of Public Administration services) receded by 4% y/y and by 2.8% y/y, respectively, while Financial Services expanded by +0.8% y/y. Latest leading indicators, including Consumer Confidence are on an upwards trajectory (to -44.5 in Apr11 from -55.4 in Dec10), which signal potential recovery in this sector. We currently look for Retail services to expand by 1.5% in 2011, given that the effects of July10 fiscal tightening measures

-17.3 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10


Source: NIS, BRD-GSG

Consumer Confidence Indicator:

0 -10 -20 -30 -40 -50 -60 -70

Consumer Confidence

(including the 25% cut in public sector wages) will gradually fade. For 2011Jan-09 Jul-09 Jan-10 Jul-10 Jan-11





Source: Eurostat

2012, we believe this sector has the potential to develop (especially in the area of financial services) as the convergence process is resumed, considering its relative small contribution to GDP (53.6% in 2010) compared to EU27 average (73.6% in 2010, according to Eurostat).

Agricultural production: 2010, %, y/y

40% 30% 20% 11.4% 10% 0% -10% -20% Cereals Oilproducing plants -17.5% Potatoes 29.8%

%, y/y

Agriculture data for 2010 (-0.8% y/y) was worse than our expectations (+2.0% y/y), as the better production of crops was offset by the decline in

vegetables production following the summer floods. For 2011, we assume a normal evolution in agricultural production, and we estimate a gain of +5.0% y/y. The evolution of Agriculture is difficult to forecast in the medium-term, being reliant on weather conditions. Moreover, its share in total GDP is very low at 5.8% in 2010. We believe there is large potential for


Source: NIS, BRD-GSG

Net taxes:

-3.0 -3.3 -4.0 -3.1




this sector to contribute more substantially to GDP, but the government should make a key priority better absorption and more efficient distribution of EU structural funds for agriculture and rural development. In 2010, Net Taxes contracted by 2.5% y/y, as the higher revenues generated by the rise in VAT rate to 24% partially compensated for the sharp drop registered in H110 (-6.1% y/y). For 2011, measures taken to

-2.7 -3.5 -3.3 -3.1

q/q -9.8 -12.6 -13.9 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 -12.2 -10.7 y/y, % change

Source: NIS, BRD-GSG

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Final Consumption:
0.1 1.1 0.4 -0.9 -1.0

decrease tax evasion and the anticipated economic recovery should help net taxes grow by 1.0% y/y. From a demand-side perspective, Consumption and Fixed Investment continued declining as expected, while Exports fared above our anticipations. Final consumption dipped 2.1% last year; this year, we expect a moderate

-3.8 -3.2 -5.0 -8.9

-1.6 -2.5 -4 -4





q/q y/y, % change

increase of 1.5%, as the negative impact of the fiscal adjustment measures from last year (the VAT hike and 15% cut in public sector wages) fades away. Indeed, private spending should recover marginally, as disposable incomes (Q410 up by +3.4% q/q, but still -3.4% y/y) show a slight upward


4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10

Source: NIS, BRD-GSG

Investment: y/y, quarterly figures

40 82 30 20 79 10 76 0 -10 73 -20 -30 70 2007Q3 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 -40

trend. Nevertheless, credit conditions for consumer loans continue tight (after NBR halted the easing cycle, interest rates on new consumer loans increased to 13.3% in Feb11 from 11.5% in Jun10). The situation should improve only marginally in 2011, with a neutral effect from the labor market and a slight positive effect from a rebound in corporate credit. Overall, final private consumption could increase by 2.0% in 2011, while government consumption should decrease by 1.5% in line with ongoing fiscal consolidation and cut in budget spending.

Capacity Utilization (EC) Fixed Investments (%, y/y - RHS)

Capacity Utilization (average)

Source: Eurostat, NIS, BRD-GSG

Saving and Investment: % of GDP

40 35 30 25 20

18 15.6 15.3 13.2 16 14 12 9.8 6.9 6.5 5.5 6.0 4.3 4.4 5.3 7.2 10 8 6 4 2 0 Q1'08 Q3'08 Q1'09 Q3'09 Q1'10 Q3'10 Domestic Investment rate (%) S-I gap (RHS) Domestic Savings rate (%)

Investment in the form of Gross Fixed Capital Formation decreased significantly by 13.1% in 2010 vs. a decline of 18.2% y/y in H110. Put in perspective, low capacity utilization rates and uncertainty about future economic developments were the main factors behind the dismal numbers. Moreover, the decline in investment was also impacted by plunging government capital investment. This year, we expect fixed investment activity to stabilize following more satisfactory capacity utilization levels, while the Exports evolution should also be promising. Overall, we anticipate

15 10 5 0


19.5 21.4 14.6 12.0 5.8 2.9 0.7 -1.4 -3.8 2.0 1.3 17.1

investments to pick up at 10% from 2012 onwards. Net exports contributed negatively to GDP in 2010, as both exports (+13.1% y/y) and imports (+11.6% y/y) displayed strong dynamics. In 2009, Net Exports played a pivotal role in avoiding a double-digit contraction, but the contribution came from the plunge in imports (-20.6% y/y) more severe than the decline in exports (-5.5% y/y). On contrast, it is worth noticing that both Exports and Imports recovered strongly in 2010, pushed by foreign demand. Imports so far have been mainly in support of Exports

4.0 0.7

-6.3 -7.2 -9.6

q/q y/y, % change


4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10

Source: NIS, BRD-GSG

24.5 14.9 8.9 4.9 -1.4 -11.1 4.9 2.6



activity, considering the weakness in domestic demand. For 2011, we look for Exports to continue around +13% y/y (real terms), while recovering domestic demand should support a mild acceleration in Imports to 12% y/y (real terms).

-6.3 -11.0 -16.1




y/y, % change



4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10

Source: NIS, BRD-GSG

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Labor Productivity per hour worked


Overall, we expect economic growth to resume this year at 1.5% y/y and accelerate to 3.0% in 2012. Romanias productivity is still only 37% of EU15 average, and has the potential for further gains during the convergence



38.1 3

process. We maintain our view that consumption and investments in infrastructure will remain the main driver of economic activity in the mediumterm, but exports will likely play a more significant role compared to previous years.

31.0 27.4 28.4 24.7


18.6 20.2


10 2000 2001 2002 2003 2004 2005 2006 2007 2008 200

Czech Republic Bulgaria

Hungary Poland


Source: Eurostat 100=EU15

We see GDP expanding by 1.5% y/y in 2011, following the 1.3% contraction last year. Industry will remain robust (+3.0 in 2011) mostly on the back of external demand. Constructions output should stabilize in 2011, but infrastructure projects and still existing housing demand will push it ahead by around 5% in 2012. Final Consumption is expected to recover only partially in 2011 at +1.5%, as the rebound in private consumption will be offset by ongoing fiscal consolidation. Investments can remain flat in 2011, and have the potential to expand in 2012, given the need for infrastructure upgrades. We anticipate Net Exports to remain negative in nominal terms, with Exports supported by foreign demand.

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II.3. Inflation Upside risks to the disinflation process

Inflation: %, y/y and 12M average (Mar11 data)

Romanias inflation surged to 8.0% y/y in Dec2010, as a consequence of the VAT rate hike implemented in Jul10, whose effects were exacerbated by ongoing supply-side shocks coming from international evolution in oil and food prices. The end of 2010 figure was larger than our initial expectations


2.7 4 4.3 4.6 1.6 1. 9 3.7


of 7.4% y/y precisely because of the supply-side pressures, as the weak domestic demand limited the transmission of the VAT rate hike. Inflation figures oscillated at the beginning of this year, declining to 7.0% y/y in
6.8 8




Ro 2

January helped by a favorable base effect, only to rise back to 8.0% y/y in March driven by surging Food and Fuel prices. The aforementioned supply-side shocks had the most significant impact on volatile food prices, oil and administrated prices. Indeed, removing the volatile and administratively distressed components we obtain a CORE2 inflation of less than 5.5% in Feb11 (compared to 4.5% y/y in Jun10 before the rise in VAT) that is a better reflection of the ongoing economic

Euro a re a

2.7 2. 4 3.1

EU 2 7
0 2


HIC P (y/y, % )

H ICP ( 1 2 M av e rag e , % )

Source: Eurostat, BRD-GSG

CPI evolution: y/y


contraction and the relatively subdued evolution in M1 (+3.3% y/y in Feb11). Food prices registered the most notable contribution to annual inflation (surging by +9.9% y/y in Mar11), driven by rising international prices which were passed through domestic prices, especially in the areas of basic foodstuffs like sugar, oil and cereals, which also enter CORE2 inflation. Indeed, although the crop production increased in yearly terms by 11.4%, we believe the higher international prices determined a large proportion of it



107 105 Food Non Food Services CPI




99 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10

Source: NIS, BRD-GSG forecast

CORE2 inflation vs EUR/RON: y/y

CORE2 (y/y, left axis) 9 8 7 6 5 4 3 eur/ron y/y 25 20 15 10 5% 0% -5% -10

to be exported (especially corn), which inevitably implies a rise in imports to cover the domestic demand. The more expensive imported cereals led to an increase in producer prices in the Food industry, which was only partially transmitted into final prices, given that falling domestic demand did not leave much room for maneuver for producers (retail sales of Food items dropped by 9.6% y/y in Feb11). Meanwhile, falling production of Vegetables (-7.7% y/y in 2010) and Potatoes (-17.5% y/y in 2010) were supply-factors behind

2 -15 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11


Output Gap
0 Q2'10 -1 -2 -3 -4 -5






the spike in the respective Food items. Weak domestic demand also influenced prices of Non-Food items included in CORE2 inflation, whose evolution was relatively more subdued. Contracting retail sales in Non-Food (-3.6% y/y in Mar11 and -2.4% y/y in Q111) and limited supply-side pressure coming from the labor-market minimized pressures on CORE2 Non-Food prices, but the rising administrated and oil prices had a negative impact. Indeed, Fuel prices rose by 4.6% in Q111, while according to Eurostat, Energy prices surged by 9.7% y/y in Mar11


-6 -7

output gap (% deviation from potential GDP)

Source: NBR, BRD-GSG

ROMANIA Economic Outlook Page 13 of 38

(below EU average of 12% y/y). On the other hand, the stronger RON (+4.0% y-t-d) against EUR was the main driver behind the evolution of Services prices, which declined by 0.42% in Q111. Going forward, there is evidence that second round effects stemming from the VAT hike will be minimal, given the absence of demand-led pressures.
Inflation and NBR key rate:
11 10 9 8 7 6 5 4 3
3.66 3.8 3.5 3.0 5.2 7.0

There are however, growing risks that inflationary expectations will deteriorate as a result of ongoing high monthly CPI figures arising from the
8.01 8.3


aforementioned supply-side factors. In its first monetary policy meeting in 2011, the NBR set the inflation targets for medium-term, namely 3.0%1.0% for 2011-2012 and decided to switch to a stationary inflation target of 2.5%1.0% starting from 2013, which would help anchor inflation expectations. For the end of 2011, we have revised upward our previous forecast to 4.9% y/y from 3.1% y/y in our autumn report to reflect the rising risks from oil, food and administrated prices. We currently expect the inflation surge to have a temporary nature and hover above 8.0% in H111, but decline significantly in H211 once the unfavorable base effect from the VAT rate

2 Dec-06






NBR inflation target (%, y/y) NBR key interest rate

CPI (%, y/y, eop)

Source: NBR, NIS, BRD-GSG forecast

Medium-term Inflation Projection:

9.0 8.0

7.0 5.2 3.80 3.66 3.50 4.9 3.5 3.00



hike exits calculations. According to the updated NBRs projections, the output gap started shrinking in Q111, but it will remain wide enough such that that it does not pose significant demand-led inflationary pressures, limiting potential second round effects from VAT hike. Moreover, we dont envisage inflationary pressures stemming from the labor market, as we see net wages remaining at best flat, while household credit is not expected to register notable recovery. There are indeed growing risks for imported inflation, but potential for a stable/stronger RON should help offset them partially. Also, there have been official comments arguing the need to liberalize the regulated prices (especially in the gas-sector), which would lead to an increase in prices in those areas. We currently expect the liberalization to occur only gradually, which will reduce the impact on CPI evolution. In the medium-term, we look for inflation to hover around 3%, with limited potential to break below it due to a variety of factors, including: economic restructuring is still incomplete, competition disturbances, huge investment needs for Utilities requiring constant rise in prices, and the liberalization of administrated prices. We expect inflation to ease towards 4.9% at the end of 2011 and fall further towards 3.5% by the end of 2012, assuming that the effect of the VAT hike will be temporary and supply-side pressures subside.

2.0 Dec-06







NBR Inflation target

inflation (%, y/y, eop)

Source: NBR, NIS, BRD-GSG forecast

ROMANIA Economic Outlook Page 14 of 38

II.4 External Sector Running above expectations

CEE countries -2010
Ro -4.2% -5.4% -3.8% 3.2% -3.3% -0.9% -1.0% -1.4% 2.1% 7.2% -6% -4% -2% 0% 2% 4% 6% 8%

Following the large adjustment registered in 2009, strong external demand helped the trade gap and consequently the current account deficit to remain at stable levels in terms of GDP. Our largest trading partners in the Euro area (especially Germany) recovered strongly and continue growing at levels above potential. After registering a deficit of EUR 6.9 bln in 2009, the Goods Trade gap (fob/fob) contracted further by 14.5% to reach EUR 5.9 bln in 2010. The improvement was driven by stronger Exports dynamics, which outpaced that of Imports on the back of a much better than anticipated revival in External Demand in 2010. Despite the recent encouraging evolutions, Romanian foreign trade remains in the negative and we anticipate it to continue so at least in the mediumterm, given the structural nature of the remaining imbalances, in which intermediate (56%) and consumer goods (22%) form the largest portion.




Hu -8%

Trade Balance (g&s)/GDP


Source: National Central Banks, BRD-GSG

Exports Structure (% of total)


Imports Structure (% of total)






6% 19%

5% 18%

2% 16%

2% 15%













7% 21% 2008
Consumer Goods Intermediate Goods

9% 24%

8% 22%



0% 2007





Other Capital Goods


Consumer Goods Capital Goods

Intermediate Goods Other

Source: NIS, BRD-GSG

Source: NIS, BRD-GSG

Exports dynamics
40 30 20 10 0 -10 -20 -30 -24.3 -0.3 -2.4 -4 37 32.2 19 15.3 5.6 11.5 5.3 26.8 24.4 17.6 14.5 36.4

Imports (+19.9% y/y in goods and 15.9% y/y in goods and services in 2010) growth was above our expectations, but most of this expansion was to support the strong export activity dynamics, as shown by the fact that the strongest growth was for intermediate goods (+26.2% y/y), while consumer goods registered a more subdued dynamics (+7.2% y/y). For this year, we expect exports to moderate somewhat (+21% y/y in nominal terms) as the base effect diminishes, but private consumption is set to expand slightly at +2.0%, leading to Import recording double-digit growth (+20% in nominal terms). Despite displaying the most robust exports performance among CEE peers in 2010, Romania continue having the lowest trade openness in the CEE region as measured by foreign trade to GDP ratio (77% in 2010) and this structural fact cannot be reversed in the short-term. Given that the current regional recovery is fuelled by exports, countries with larger degree of trade

2007 Capital Goods

2008 Intermediate Goods

2009 Consumer Goods

2010 Other

Source: NIS, BRD-GSG forecast

ROMANIA Economic Outlook Page 15 of 38

Relative trade openness (g&s) -2010


openness and stronger ties with countries from the Euro area and Germany benefitted the most. Indeed, Poland (+3.8% y/y) and Czech Republic (+2.4% y/y) enjoyed the strongest rebound. Moreover, although Final Domestic Consumption contracted severely during the two-year economic recession, it still represents 79% in total GDP in 2010 (slightly less than 82%

78.9% 73.4% 59.3% 42.3%







registered in 2008). However, as shown by the changing structure of both exports and imports, in the medium-term Romania promises to move from Exports in low value-added goods to Intermediate and Capital goods. Also, we expect Exports to continue robust (at nominal growth rates around 20% in the medium-term), which means they will play a more significant role in shaping a more sustainable path of economic recovery. Overall, this evolution will determine the trade gap to widen to EUR 7.4 bln in 2011 and EUR 8.4 bln in 2012.

76.6% 57.9% 41.4% 35.7%




Czech Republic




Source: Eurostat, NBR, BRD-GSG

Trade Gap: nominal, EUR bln & y/y, %

+25% +16% 54 37 42 +16% +13% 61 -15% 21% 16% +21% +20% 5360 +22% +21% 73 65 +23% +22% 89 79

-29% 44 50 36 43








The Current Account Deficit contracted even more than the Trade Gap in 2009, as it fell by 70% y/y to EUR 4.9 bln or 4.2% of GDP (against EUR 16.2 bln or 11.6% of GDP in 2008). The adjustment of the external shortfall has been supported not only by the narrowing Trade Gap, but also by still robust Net Transfers, mainly in the form of private remittances. Current Account figures for 2010 were better than our expectations (deficit








Imports (fob)

Trade Gap (fob/fob g&s)

Source: NBR, BRD-GSG calculations

CA/GDP and FDIs/GDP: %, 2010

6.0% 4.5% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% -1.0% -3.3% 3.0% 2.1% 3.5% 2.1% 2.1%

widened slightly by a revised figure of +1.0% y/y to EUR 5.0 bln), driven mostly by stronger than anticipated exports, combined with a relative stabilization in net transfers decline. Even if we account for high Imports



rates to support the stronger Exports, the Trade Gap (g&s) still narrowed sufficiently (-9.0% y/y) to determine a relative stabilization in the current account shortfall. Net transfers decline occurred on the back of lower remittances mainly from workers in Spain and Italy, as the financial crisis in those countries contributed to high unemployment rates and lower wages. We expect current private transfers to stabilize around these levels, considering the slow economic recovery in the aforementioned countries, persistent high unemployment and fiscal austerity measures. Nevertheless,


Bulgaria FDIs/GDP


Czech Republic



Source: Local Central Banks, NBR, BRD-GSG

Current Account Deficit: 12M rolling: y/y, %

70% 50% 30% 10% -10% -30% -50% -70% Dec-06

Current Account Trade Gap Incomes Net Transfers

Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10

we see potential for government inward transfers to increase (as supported by 12M cumulative figures) if the recent taken measures result in better absorption of EU structural funds, as is committed under the new IMF/EC precautionary deal. Preliminary data for 2M11 show the Current Account deficit narrowing significantly by 94% compared to 2M11 to EUR 44m. The main driver remains strong exports evolution, but we notice a rebound in current transfers surplus, mainly driven by government inward transfers. We expect

Source: NBR, BRD-GSG calculation

Net Transfers: 12M rolling, EUR m

7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Dec-05 -1,000






private remittances

government transfers

total transfers

the Current Account Deficit to remain within manageable levels around 4-6%

Source: NBR, BRD-GSG calculation

ROMANIA Economic Outlook Page 16 of 38 Current Account and Trade Gap: % of GDP
13.9% 13.6% 13.2% 11.6%

of GDP over the medium-term. Although we anticipate Domestic Demand to recover gradually starting with Q211, it is unlikely it will reach levels similar to the ones before 2009. Ongoing fiscal tightening (to meet the 4.4% fiscal target in 2011 and further to 3.0% of GDP as outlined in the Ministry of Finances recently published Medium-Term Fiscal Policy) implies lower disposable incomes. Moreover, we expect that post-crisis access to external financing will be harder to obtain, given the likely increase in perceived cost of country risk for the region. Overall, these two factors will effectively cap expansion in domestic consumption (both private and investments) and limit imports growth. Overall, we have lowered our estimation for Current Account deficit to 4.3% in 2011 and 4.5% in 2012 in line with the gradual recovery in Private Consumption and improvement in Net Transfers coming mostly from government transfers in the form of EU structural funds.

12.1% 10.2%

5.6% 4.3%

5.4% 4.1%

5.8% 4.5%

6.2% 4.2%






2011f 2012f 2013f

Trade gap (fob/fob g&s)

Current Account Deficit

Source: NBR, BRD-GSG forecast

Financing of C/A deficit: 12M rolling

25,000 20,000 15,000 10,000 5,000 0 -5,000 Dec-05 Dec-06 Dec-07 Dec-08 Dec-10

6.3% 4.8%

FDIs IMF loans

Net foreign private capital inflows Current Account

In terms of financing sources of the current account, during the pre-crisis years, the perceived low cost of country risk and the liberalization of the capital account in 2006 brought large inflows of private foreign capital. They helped finance the strong demand for private loans (focused especially on consumer and mortgage loans) determined by the convergence process, but also fuelled a ballooning current account deficit. Nevertheless, in the context of the global financial crisis, these private inflows turned negative at the beginning of 2009, and although still robust, FDIs alone were not sufficient to finance a still large current account deficit. The rest had to be covered from the FX reserve and in the end, a Stand-By agreement with the IMF/EC proved necessary to maintain financial and currency stability. In 2010, net private capital inflows recovered only partially, but together with FDIs, were sufficient to fund a moderate current account deficit EUR 5.0 bln (almost unchanged from 2009 levels). Thus, the rest of the IMF tranches which entered NBR accounts increased FX reserve assets, which reached new historical levels of EUR 32.8 bln at the end of Mar11, up from EUR 28.0 bln at the end of Jan10. In this context, Romania decided not to draw on the last tranche from the IMF worth EUR 0.9 bln, which was scheduled for Jan11. In terms of foreign direct investment, data from the financial account shows that FDIs plunged 25.6% y/y in 2010 to EUR 2,600 million and cover only 52% of the external gap in 2010 (compared to 71% in 2009). This decline can be attributed to increased reluctance to invest in Romania due to uncertainty about fiscal consolidation, political tensions and economic recovery lagging behind regional peers in 2010. Nevertheless, we anticipate that Romania will probably remain attractive for foreign investors, especially since the government proved its commitment to bring down the fiscal deficit as planned, which should lead to a rebound in FDIs in 2011 to EUR 3.5 bln

Source: NBR, BRD-GSG calculation

Portfolio investments: RON bln, 12M rolling

EUR bn


Portfolio investments (12M cumulative)




-1.5 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10

Source: NBR, BRD-GSG calculation

ROMANIA Economic Outlook Page 17 of 38

and increase further to EUR 4.5 bln in 2012. This could reasonably cover around 61% of the Current Account Gap.

We anticipate the Trade Gap (g&s) to widen to 5.6% of GDP in 2011 and to 5.8% in 2012 in line with the moderation in Exports and a pick up in Imports which should accompany economic recovery. Current Account is expected to stabilize at moderate levels below 5.0% of GDP by 2012, also helped by a pick-up in government transfers.

ROMANIA Economic Outlook Page 18 of 38

II.5. Fiscal Policy and Public Debt Following the austerity flow
The pro-cyclical fiscal policy adopted by the government during the boom
Budget Stance (% of GDP)
RONmld 50% 40% 30% 20% 10% 0% -10% 0

years created large structural imbalances which asked for severe adjustment measures in 2010. Specifically, the consolidated fiscal gap widened from 1.52.5% of GDP in 2001-2007 to 4.8% in 2008 and 7.4% in 2009, despite the robust growth rate of 7.2% in 2008. To reduce the fiscal deficit to 6.8% in 2010 as agreed with the IMF/EC, the government acted on several levels by implementing socially unpopular measures. The main ones focused on cutting expenditures, which included the 25% reduction in public sector wages, 15% cut in social transfers except pensions (rules as unconstitutional) and the elimination of special pensions (except the ones for magistrates, ruled as unconstitutional). On revenues side, the changes to fiscal code in Jul10 included hiking the VAT rate to 24% from 19% previously and enlarging the taxation base by applying a 16% tax rate on bank deposits, 16% tax on lunch and vacation vouchers, a 16% income tax on freelancers activities and a solidarity property tax on properties other

38% 31%

39% 33%

37% 32%

36 % 33%

35 % 32% -16

-5 -10 -15 -20 -25 -30

-18 -24 -33

-36 -7.2%


-4.4% Dec-11e

-3.0% Dec-12e

-2.5% Dec-13e

-35 -40


Revenues (% of GDP) Fiscal Deficit (% of GDP)

Expenses (% of GDP) Fiscal Deficit (nominal, RHS)

Source: Ministry of Finance; BRD-GSG calculations

Stock of arrears (Actual vs. Target): RON bln


1.76 1.55 1.41 1.4 1.1 0.91 1.5

1.8 1.57

Actual IMF targets



1.2 1.06

1.09 0.81



than the residence.


0 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11

The aforementioned measures helped the budget deficit consolidate to 6.5% of GDP in 2010 (preliminary figures), but the results could have been even better. Indeed, the 25% reduction in public sector wages led to a decline in personnel expenses by 8.6% y/y in 2010, but net wage data from NIS show that the decrease was unequally distributed among different public sectors. Thus, wages in Education sector dropped by 17.9% y/y and by 19.1% compared to Jun10, while the decrease in Public Administration wages was less acute at 12.9% y/y and 5.4% compared to Jun10. In addition, the 2011 budget include a 15% increase in public sector wages to compensate for the July cut. In terms of decreasing social transfers, a deteriorating labor market led to an increase in social assistance spending (+7.3% y/y in 2010) despite the changes to the fiscal code. Moreover, dwindling Capital expenditure (11.7% y/y in 2010) also helped maintain the budget deficit below the agreed target, but at the expense of necessary investments in infrastructure that would have increased productivity and living standards in the long-term. On revenues side, the measure to hike the VAT rate was also only partially successful, as VAT revenues rose by 14.3% y/y in 2010, since the 26.3% increase in VAT rate (from 19% to 24%), was not fully transmitted into prices, while higher taxation probably encouraged increased tax evasion. As agreed in the new IMF/EC precautionary agreement, the government targets to reduce the fiscal deficit in 2011 to 4.4% of GDP and bring it down to 3.0% in 2012 and 2.5% in 2013 (cash methodology). According to the

Source:IMF Letter of Intent and Technical Memorandum: April 11

ROMANIA Economic Outlook Page 19 of 38

medium-term fiscal strategy published by the Ministry of Finance in midSeptember last year, the government aims to increase VAT revenues (7.8% of GDP in 2013 from 6.8% of GDP in 2009) and improve absorption of EU funds (2.5% of GDP in 2013 from 0.4% of GDP in 2009). Moreover, it relies on heavy expenditure cuts in the coming years, which will be achieved mostly by cuts in Personnel expenditures (down to 6.6% of GDP in 2013 from 9.2% of GDP in 2009) and Social Assistance (down to 11.4% of GDP in 2013 from 12.7% of GDP in 2009). The government already passed at the end of last year legislation meant to support the fiscal adjustment, which include the pension reform and the law regarding a unitary payment system for civil servants. Nevertheless, there are still areas that require increased attention, including the reform of loss-making state-owned companies, as indicative targets for a reduction in arrears were repeatedly missed during the two-year deal. The new precautionary
Public Debt Structure by instrument (%)
100% 22% 80% 39% 41% 17%

agreement focuses on privatization and increased monitoring of the most significant state-owned companies, with the purpose of reducing arrears that also hinder economic recovery. Moreover, the government is committed to implementing laws aimed at increasing employment, as the recent trends are not encouraging, despite the decrease in the unemployment rate. To that extent, the government effectively passed the modified labor code, after assuming responsibility for it and surviving a no-confidence vote in Parliament in February. Last, but not least, the government is taking concrete steps to increase the rate of absorption of EU structural funds, which includes moving the project management unit from the Ministry of Finance to the PMs office and encouraging private sector involvement. We do believe EU structural funds have the potential to support higher investments while keeping the budget deficit in check, but it remains to be seen whether Romanias poor track record






33% 17% 19% 6% 18%


9% 9% 8% 10% 3% 2007 2008 Government bonds 8% 2009

7% 17%


2010 Other sources



State loans

Source: Ministry of Finance, BRD-GSG

Public Debt structure by currency (%)

100% 12% 80% 28% 31% 60% 41% 43% 10% 6% 5%

40% 53% 20% 60% 48% 45%

in attracting them can be turned around. Moreover, we still see endemic fiscal evasion as the governments largest problem, and believe it is vital to find solutions to improve tax collection and combat mounting fiscal evasion. The public debt profile deteriorated in the past two years as a result of the ballooning fiscal deficit. Indeed, total public debt rose to 37.8% of GDP at

0% 2007 RON EUR 2008 USD 2009 JPY 2010 Other currencies

Source: Ministry of Finance, BRD-GSG

Stock of Government Debt: % of GDP

80% 70% 60%
51.0% 56.3% 53.1% 42.1% 31.9% 47.1% 39.6% 55.8% 78.3% 73.0% 78.9% 77.8%

the end of 2010, up from 30% at the end of 2009 (according to the Romanian methodology). Moreover, the general government gross debt also rose to 23.9% at the end of 2009 from a mere 13.4% at the end of 2008 (according to EU methodology). In terms of currency, RON-denominated debt decreased as a proportion of total debt to 45.3% in 2010 from 60% in 2008, mostly on the back of receiving tranches from the IMF/EC aid-deal

50% 40%


35.4% 29.8% 30.4% 23.7% 13.6% 31.8%

30% 20% 10% 0%







Czech Republic



used to finance the fiscal deficit. Nevertheless, the maturity profile improved, as medium and long-term debt increased as a proportion of total debt from

Source: Local Ministries of Finance, BRD-GSG interpretation

ROMANIA Economic Outlook Page 20 of 38

50% in 2008 to 64.8% at the end of 2010. We currently expect public debt to peak slightly below 40% of GDP in 2011, which is still considerably less in international perspective and within CEE region. Also, it is comfortably below the Maastricht limit of 60% of GDP. Moreover, as the fiscal gap continues its downward trend in the medium-term, public debt is also expected to decline in line with the fiscal consolidation and repayment of the IMF/EC loan. The government targets a fiscal deficit of 4.4% of GDP for 2011 and 3.0% for 2012 by further cutting expenses, but we believe improving tax collection and reducing fiscal evasion are absolutely mandatory to achieve that goal.

ROMANIA Economic Outlook Page 21 of 38

II.6. Labor Market The new labor code: A step forward?

800 700

Labor market is one of the areas that require most reforms, and the

recession proved an opportunity for corrections. Latest developments in labor market indicators suggest at best a mixed evolution. Thus, starting in

600 500 (4.2%) (4.4%) 300 Dec-07 ( 3.7%) Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10

April10, unemployment rate (as reported by the National Labor Agency) entered a descending trajectory, decreasing constantly to reach 5.9% in March11 from a peak of 8.4% in March10. Meanwhile, unemployment according to ILO methodology stood much higher at 7.3% in Q410 (up from 6.9% in Q311). Also, employment rate (active population between 15-64 year) deteriorated to 57.9% in Q410 from 60.2% in Q310, with the lowest employment percentages for the age group between 15-24 years (a mere 22.5%). In this context, we attribute the falling unemployment rate to the calculation methodology employed by the National Labor Agency, as well as to the fact that unemployed did not register with the Agency once they stopped receiving unemployment benefits. However, we still see little improvement in the labor market, as also supported by the declining unit labor cost and declining average net salary. Moreover, there is still enormous pressure to slash public sector jobs, given the still high number of public workers. We argued in our previous report that the Romanian labor market can be characterized by low flexibility and high taxation. Specifically, the market is highly unionized, the trial/test period of new employees is extremely limited (1-3M), and the terms of the contracts show little flexibility for the employers. The consequences of the rigid labor market include delays in


Source: Romanian Employment Agency, BRD-GSG forecast

Employment rate and unemployment (ILO)

62% 61% 60% 59% 58% 57% 56% 5.4% 55% Q3'06 Q1'07 Q3'07 Q1'08 Q3'08 Q1'09 Q3'09 Q1'10 Q3'10 5% 8.1% 9% 8% 8% 7% 7% 6% 6%

Employment rate

unemployment BIM

Source: NIS, BRD-GSG

Unit Labor Cost Index: %, y/y

25 20

Unit Labor Cost

15 10 5 0 -5 2007Q4 2008Q2 2008Q4 2009Q2 2009Q4 2010Q2 2010Q4

Source: NIS, BRD-GSG

restructuring (especially in the public sector) due to law protection and stiff bureaucracy for collective/individual dismissal, which encouraging undeclared work. Moreover, foreign investments are dissuaded since investors prefer other EM countries with more flexible labor markets. Recent developments in this sense include the passing of the new labor code, which aims exactly at more flexibility by promoting temporary contracts and imposing drastic fines on undeclared work. Although this is a step forward, it remains to be seen whether the measures can be implemented effectively.

Unemployment should rise to 7.5% in 2011, if the restructuring the public sector continues. However, the expected GDP growth pickup in 2012 implies unemployment rate should moderate towards 7.0%.

ROMANIA Economic Outlook Page 22 of 38


Financial Market

III.1. Monetary policy Caught between a rock and hard place

From flood to drought and back


excess liquidity: -large sterlization -moderate spread over key rate

10.25 8.3 7.00


0.75 RON BLN

10.00 9.50


excess liquidity -NBR sterlization -key rate and interbank rate re-coupled


liquidity shortage -liquidity injections -key rate and interbank rate de-coupled



Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10

+ Sterlizations/-Injections
Source: National Bank of Romania, BRD-GSG calculation


Key Rate

CPI and Key rate scenario: %

12 10

Surging inflation driven by the VAT rate hike in Jul10 led NBR to halt the previous expansionary cycle in spite of the negative output gap, subdued domestic demand and tight credit conditions. Thus, it kept the key interest
8 8.34

8 6 4
3.66 5.17

rate unchanged at a record low level of 6.25% after cutting it by 175 bps in

the first half of 2010. Acting in this manner was seen as maintaining its prudent stance in order to anchor inflation expectations and ensure monetary and financial stability over the medium-term, as the inflationary spike (inflation reached 8.0% y/y in Mar11 to bring about negative real interest rates of -175 bps) is still seen as temporary. Indeed, we expect in line with market consensus that the VAT rate hike will only produce a direct impact, as the wide output gap and persistent weakness in domestic demand would limit second-round inflationary pressures. Consequently, we anticipated inflation will ease gradually in Q111, once the negative effect of 2009 increase in tobaccos excise duties will exit calculations, and NBR will have room to resume monetary policy easing. However, the subsequent unfavorable price development in oil and agricultural commodities in external markets jeopardized our baseline scenario. Indeed, it translated into persistently high monthly CPI figures, which made us revise our 2011 eop inflation forecast to 4.9% from 3.1% in our Autumn REO report. In order to reflect this change, we also revised our eop interest rate estimates to 5.75% from 5.5%. We believe NBR will remain on hold at least until Q311, while the firm resumption of the disinflation process should allow NBR for rate cuts by the end of 2011. Nevertheless, we see ongoing supplyside risks coming from price developments in food and oil prices,


2 Dec-06

Dec-07 Dec-08 CPI (%, y/y, eop)


Dec-10 Dec-11 NBR key rate

Source: NBR, NIS, BRD-GSG forecast

Key rate spread over inflation: bps


Spread over realized inflation

500 400 300 200 100 0 -100 -200

Spread over future/expected inflation










Source: NBR, NIS, BRD-GSG forecast

ROMANIA Economic Outlook Page 23 of 38

exacerbated by discussions to liberalize administrated prices (especially in the gas market), which could determine NBR to remain on hold this year. For the medium-term, we believe there is limited space to cut interest rates below 4.5% beyond 2012 as long-term inflation drivers (like competition distortions, regulated prices, recovery in Domestic Demand) still lurk behind the current, temporary negative output gap. As far as the ratios of required reserves are concerned, Central Bank decided to lower the reserve ratio for FX liabilities to 20% from 25% in a surprise move at its end of March meeting. A potential explanation lies in MinFin intention to issue on the foreign market a medium term note by the end of H1. By releasing around EUR 1.0 bln, NBR increased euro liquidity in the banking system in anticipation of the government issuance. Otherwise, it is also an easing measure that would normally encourage FX credit. Nevertheless, it is unlikely this is the reason behind NBRs move, if we consider that FX loans are already a significant part of total loans. We believe that required reserve ratio for RON will remain unchanged in the coming months, considering the abundant RON liquidity in the banking sector, which make liquidity injections through use of this instrument unnecessary. We expect the key rate might be lowered to 5.75% at the end of 2011, and further to 4.5% in 2012 if our baseline scenario for the CPI, GDP and FX materializes.

ROMANIA Economic Outlook Page 24 of 38

Resuming the net debtor status NBR operations with local banks recrudescence of deposit taking activities
RON bln

domestic secondary market

III.2. Money Market and Government Bonds Consolidating the

During Q410-Q111, short-term interest rates in the money market

70 50 30 10 -10 -30 -50 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11

Lending facility Deposit facility

decreased to lower levels compared to the previous quarters, helped by the accommodative liquidity conditions in the banking system. The average level for O/N rates was 3.67%, with the usual pattern of temporary spikes towards 5.5%-6% at the beginning of the new reserve maintenance, but gradually declining towards the NBR rate of the deposit facility of 2.25%. However, this pattern was briefly interrupted in Jan-Feb11, when MinFin took advantage of better market conditions to issue more than the planned amount, which effectively resulted in a net cash outflow from the system and a temporary tightening of liquidity conditions. This caused money market rates to remain around 6% for most of February, only to resume the usual

Source: NBR, BRD-GSG

Inter-bank liquidity and interest rates

Interbank transactions Stock of inter-bank deposits Spread ROBOR 3M over key rate
+8 pp

pattern once the governments issuance was lighter. Excess interbank liquidity, which is hold by the banks at the Central Bank deposit facility,
2.4 0.6 0.7 0.2

+3 +1 0 excess liquidity -2


makes it very easy to borrow very-short term, at low interest rates.


Meanwhile, 3M maturities also adjusted downward below NBRs key rate to average 6.1% in Q410-Q111, helped by improved perception that current loose liquidity conditions will remain supported by NBRs liquidity














Source: NBR, BRD-GSG calculations

Who owns treasuries? Oct. 2010


management operations. To a smaller extent, this evolution was also transmitted into interest rates for loans and deposits, although with a lag. The yields on the both primary and secondary government securities markets had an oscillating evolution since our previous report. In line with our


expectations, the MinFin gave up the self-imposed cap of 7% on new issues which caused significantly undersold auctions during Q310. As a consequence, yields rose temporarily towards 7.2% for 1Y, but the successful placement of a 3Y euro-denominated note at the end of


November supported lower yields. Moreover, the governments completion of

Residenthouseholds Foreign

Bankingsector Life&Pensions
Source: MinFin, BRD-GSG calculations









consolidation, especially after the 2010 fiscal deficit was better than expected at 6.5% of GDP. Together with the improved economic outlook, it led to an increased appetite from part of non-residents. Indeed, latest MinFin data shows that the proportion of non-residents holdings of government securities doubled from 7.0% in Oct10 to 14% in Jan11, while in nominal terms, the amount held

Who owns treasuries? Jan. 2011

2% 18%

14% 66%

by non-residents increased even more (2.6x) to RON 7.8 bln from RON 3.0 bln. Given the low borrowing costs and their specific constraints, foreign demand was concentrated on 1Y sector, while longer maturities enjoyed only

Ba nki ngSector Li fea ndPens i ons

Forei gn Res i dentHous ehol ds

Source: MinFin, BRD-GSG calculations

ROMANIA Economic Outlook Page 25 of 38

lackluster interest. This situation led to a steepening of the yield curve, as short-end fell below 6.8%, while longer 3-5Y edged higher at 7.3%.
Funding programme
2008 Gross borrowing requirements (RON bn) Fiscal gap (surplus/deficit) 24.7 36.4 33.3 5.2* 41.6 46.7 15.5* 20.7 24.0 2009 2010 Y-t-D Estimate 2011**

Revenues Expenditures
Public debt service Total Funding Sources (RON bn) State loans, out of which

164.4 189.1
14.3 39.0

156.6 193.0
56.7 93.1

168.6 201.9
45.6 78.9

179.2 203.2
61.8 85.8






-c ontracted directly (incl. IMF/EC) -s tate guaranteed

Issuances of treasury securities -domestic capital market

15.5 15.2 12.0

35.1 2.1
76.1 76.1

6.0 5.4
56.2 51.9

8.4 0.3
26.9 26.9 (48% of total)

8.4 4.0
67.6 56.0

T-bills T-Bonds (incl. euro-denominated)

-international capital market

6.5 5.5

68.4 13.7

38.7 13.2

18.1 (58.8% of total) 8.8 (34.9% of total)

0 0 0 2.7 38.30

30.8 25.2

Eurobonds Eurobonds part of EMTN

Cash management instruments

3.2 1.8

0.0 113.27

4.3 3.0 70.60

10.0 90.00

Total 32.56 Source: Ministry of Finance, BRD-GSG * Q111 ** Ministry of Finance, BRD-GSG estimations

In terms of borrowing needs for 2011, Romania targets a fiscal deficit of RON 24 bln and it needs to pay debt service of an estimated RON 61.8 bln (including the debt service for new debt to be issued). According to the recently approved Debt Management Strategy for 2011-2013, financing from
IMF/EC/WB Stand-By Agreement
Sources IMF EC 1Q09 2Q09 3Q09 4Q09 Total 2009 1Q10 2Q10 3Q10 4Q10 Total 2010 1Q11 2Q11 3Q11 4Q11 Total 2011 4.9 1.85 6.75 2.45 1.8 0.9 5.15 0.0 WB 0.3 1.5 1.5 1 1.15 2.15 1.35 0 0.7 0.3 1.0 1 EBRD & EIB Destinations NBR 4.9 0.9 5.8 1.23 1.8 0.9 3.9 0.0 MoF 0.3 2.4 1.0 3.7 2.23 1.15 3.4 2.1

the external markets in 2011 includes 56.5% of fiscal gap (RON 13.6 bln) and the refinancing of the external public debt service (estimated at RON 6.6 bln) for a total of RON 20 bln. Of this amount, the Ministry of Finance received the last tranches worth EUR 2.0 bln from the EU/WB 2009-2011 aid-deal agreement, while for the rest it is expected to tap foreign markets. Indeed, according to official declarations, MinFin is expected to issue a Eurobond by the end of H111 (part of the announced EMTN 3-year program totaling EUR 7.0 bln), also depending on market conditions. If we consider the total of EUR 2.5 bln maturing in Jul11, MinFin should tap foreign markets at least once. Nevertheless, considering the flexibility offered by the EMTN program, it was possible for MinFin to issue euro-denominated bonds on the local market instead of the Eurobond given the uncertainties of the external environment. Indeed, at the beginning of May, MinFin sold EUR 1.0 bln in 3Y euro-denominated T-bonds (more than the initial planned amount of EUR 0.6 bln), which reduced its FX borrowing needs in order to finance the July peak.








0.0 9.75

2.1 9.15


ROMANIA Economic Outlook Page 26 of 38

Also, MinFin announced its intention to issue government securities in higher amounts that borrowing needs (by around RON 3.4 bln annually for 10 years) in order to gradually eliminate the deficit from the State Treasury Current Account. The Debt Management Strategy mentions a deficit of RON 31.4 bln at the end of 2010, created from borrowings used to finance
Repayment schedule for IMF/EC loan
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 300 1,000 1,150


122.41 954.53 987.09 124.96

EC EUR mln

WB EUR mln

previous budget deficits. Considering this, we estimate that a total of around RON 56 bln needs to be borrowed from the domestic market in 2011. The MinFin already announced its intention to lengthen the maturity of its issuances in order to reduce refinancing risk. Thus, for 2011 it aims to increase the proportion of medium and long-term securities (T-bonds) to 4050% of total issuance. Thus far, it has issued around 59% of the estimated amount for T-bills on the domestic market, while the figure for T-bonds stands less impressive at 35%. Overall with the above assumptions, it has already secured around half of the total borrowing needs for 2011, which means domestic market would need to absorb lower securities issuance, especially in the T-bill sector. On the contrary, we see heavier issuance in the longer maturities sector, with new benchmarks issued. As such, we remain bullish on shorter-term, while seeing room for further steepening of the yield curve.


Source: MinFin, BRD-GSG calculations *the amount scheduled for EC does not include the last tranche worth EUR 1.35 bln

ROMANIA Economic Outlook Page 27 of 38

III.3. Forex Market More bullish perspectives long-term

The last quarter of 2010 saw lowest volatility among regional peers for the domestic currency, as it traded in a tight interval between 4.25-4.30, largely unaffected by domestic or external factors. However, the successful
HUF -5 -10 -15 -20 -25 -30 -35 PLN

CEE Currencies against the euro: % since Jan08

appreciation Dec '07= 0% 10 5 0

implementation of prerequisites necessary to keep the IMF/EC on track, which included a reduction in fiscal deficit to 6.5% and passing of several key reform laws improved investors sentiment towards RON and determined a recent rally which saw RON gain 4.0% y-t-d. Nevertheless, a glance at the









Source: NBR, BRD-GSG

recent real effective exchange rate reveals that the recent RON appreciation was no cost disadvantage to Romanian exporters, as RON REER is still below the value implied by long-term trend. Moreover, extremely strong Export dynamics (+41.9% y/y in 2M11 in goods) also reflect the strength of foreign demand. EUR/RON evolution in 2010:
4.40 EURRON EUR reches historic maximum of 4.3835 RON after Constitutional Court rejects pension cuts by 15%

Regional Currencies against the euro: % since Jan11



Note: Dec.31= 0.0 (%)

4 2



-2 -4


Slight firming after govt survives a new no-confidence




-1 0

Jan Feb Mar Apr


Source: NBR, BRD-GSG


Reduced volatility on the back of NBR indirect interventions

Real effective EUR/RON exchange rate: 2005=100, real (CPI-based), monthly average
130 120 110 y = 0.0074x - 189.62 100 90 80 70 60 Jan-98
Romania REER Linear (Romania REER)

4.15 Depreciation trend determined by local uncertainties about fiscal consolidation, exacerbated by external tensions S&P cuts Greece rating to "junk", onset of the sovereign debt crisis Jun-10 Aug-10 Oct-10


Firm appreciation triggered by improved economic outlook, ongoing fiscal consolidation and a new precautionary IMF/EC agreement


26 April 2011, Last 12months low of 4.0735

4.00 Apr-10




Source: Reuters, BRD-GSG comments

We believe that the RON rally has been too brisk in the past weeks and most
Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

Source: BIS, BRD-GSG

likely is unsustainable. We expect RON will probably undergo a technical correction, which has already started with foreign investors taking profit by closing their positions. However, improving economic fundamentals make us more bullish on the RON in the medium-term. Thus, we now estimate that EURRON has the potential to reach 4.05 by the end of 2011 compared to 4.15 in our previous REO. Economic growth should resume sustainably in H111 and even accelerate in the second part of the year, while the new IMF/EC precautionary agreement will likely boost investors confidence that fiscal consolidation will remain on track. Together with stabilization in public debt below 40%, it has notably reduced the internal imbalances. Moreover, the lower than expected current account balance (driven by strong exports dynamics and a lower trade gap)

ROMANIA Economic Outlook Page 28 of 38

being financed by FDIs inflows show a marked reduction in external imbalances which should further support RON. At the same time, recent supply-side inflationary pressures coming from oil and food prices make it less likely for NBR intervention to curb RON appreciation, given the need to anchor inflationary expectations at low levels. In contrast to our previous report, we now believe the main risks arise from unfavourable external developments, which could trigger a wave of risk aversion with a negative impact on risky assets. Thus, uncertainties about the conflict in oil-producing country Libya, together with the aftermath of Japanese earthquake and management of the nuclear crisis are exacerbated by ongoing sovereign debt worries. Thus, considering Irelands and Portugals bailout packages at the end of 2010 and beginning of May11, the external environment has been volatile. Moreover, domestic risks cannot be overlooked, since there are ongoing risks of fiscal slippages given that 2011 is a pre-election year. Nevertheless, we maintain our view that there is limited potential for the RON in stabilize below 4.0 considering that: FX inflows comparable with the 2005-2007 period are unlikely to reoccur; Imports are expected to accompany economic recovery. Although not spectacularly, the trade gap is expected to continue moderate growth in 2011. There is some empirical evidence that already reveals increasing demand for FX: positive Imports dynamics, higher sales of FX to clients, a moderate pick-up in FX corporate loans. The payback obligations arising from the Stand-By Agreement will put pressure on the Central Bank reserves in 2012-2015 as a total of SDR 11.6 bln have to be returned. We believe the recent rally will be followed by a technical correction bringing EURRON to 4.15 in June. Nevertheless, improved economic fundamentals make us more bullish on RON in the medium-term, while higher supply-side inflationary pressures diminish the risk of NBR intervention to curb RON appreciation. Thus, we now see potential for EURRON to reach 4.05 at the end of 2011.

ROMANIA Economic Outlook Page 29 of 38

III.4. The Capital Market Still running to catch up

The BSE evolution: After the 2010 spring bullish trend and the decline
BET index vs. daily volume evolution (Apr08 Apr11)
Volume Th 600,000 550,000 500,000 450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 1,000 4,000 3,000 2,000 7,000 6,000 5,000 BET, rhs axis 9,000 8,000

which followed at the beginning of the summer due to worsening macroeconomic conditions, Romanian Stock Exchange exhibited in the second half of 2010 a sideways evolution accompanied by minimum liquidity levels. After the shock of Greek crisis followed by European sovereign debt crisis, investors adopted a passive attitude and nor buyers nor sellers have decided to act to define a clear trend of the market. Since the beginning of 2011, the local stock exchange entered on an ascending path fuelled by the highly expected listing of Fondul Proprietatea (January 25, 2011) which also brought higher liquidity to the market and followed by good preliminary 2010 financial data and generous dividends announcements from main issuers. The consolidation of this good start depends on the confirmation that economy is recovering together with the release of macro economic data for the first quarter of the year in May11. Other positive triggers would be the announced Secondary Public Offerings of the state for selling minority stakes in Petrom, Transelectrica and Transgaz. On the negative side, the comparison of Romania with other emerging markets which compete for international investors money is still in our disadvantage because of a prolonged recession and pale signs of recovery, while other countries already showed early recovery and better growth perspectives. Coming back to the market evolution, we have tried to sketch in the graph below an explicit picture of the general evolution that characterized our domestic market during the last period and the specific events that influenced its developments.
BET vs. BET-FI evolution & major events (Dec09 Apr11)
60.0% BET BET-FI

0 0 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Dec-10 Apr-11

Source: BSE, BRD-GSG calculation

Previous update
21Mar11 - Enforcement of local indices composition changes; FP included in both BET and BET-FI Sideways evolution on meager trading activity +25.2% vs. end Dec09

End of Feb09 - Apr10 rally: BET and BET-FI up by 225% and 324%, respectively vs. previous historical lows (Feb09) EU countries sovereign debt crisis triggered by Greece fueled risk aversion on the international markets


- Ex-ante FP listing (25May10 - 24Jan11) avg. daily BSE turnover amounted to a poor EUR 4m 20.0% - Ex-post FP listing (25Jan11 - 29Apr11) avg. daily BSE turnover rebounded up to EUR 12.5m

+6.1% vs. end Dec09


Ireland bailout Feb-Mar10: Major rating companies revised upwards the outlook for Romania from "negative" to "stable" 3Mar11: Q4'10 GDP reported at +0.1% qoq, adj., real terms; 2010 GDP reported at -1.3% yoy, real terms 25Jan11 - Fondul Proprietatea (FP) technical listing on BSE platform Dec-10 Feb-11 Apr-11

-20.0% The Constitutional Court ruled pension cuts as illegal; Government decided to rise VAT up to 24% from 19% and cut public wages by 25% to meet IMF fiscal targets Feb-10 Apr-10 Jun-10 Aug-10 Oct-10

-40.0% Dec-09

Source: Reuters, BRD-GSG

ROMANIA Economic Outlook Page 30 of 38

Since our previous report in October 2010, BET has gained 12.1% (thus reaching 5,922 at end April 2011), whilst BET-FI, the composite of our six closed-end funds, SIF 1 to 5 and FP (with the latter included in BET-FI
Investment activity on BSE (nonresidents), Shares segment, Regulated market
Purchases non-residents RONm 500 400 300 200 100 0
Dec-08 M ar-09 Jun-09 Sep-09 Dec-09 M ar-10 Jun-10 Sep-10 Dec-10 M ar-11

structure starting 21 Mar11), has gained 5.2% up to 25,566. BET-FI growth accelerated since the beginning of the year fuelled by consistent dividends announcements. All in all, the current values are still at high discounts from the levels registered three years ago when equities approached their pre crisis peak. As such, BET reached a value that is 39% lower than its maximum from 2008, while BET-FI is now around 67% under its peak traded levels from 2008. Fund flows: In last 12M cumulative ending in March 2011, the average non-residents purchase volumes have increased by a slight 1% y/y while residents purchase volumes declined by 17.4% y/y. On the sales side, average monthly non-residents sales have grown by 39.7% y/y, but residents sales decreased by 23.7% y/y. The total volumes have reached RON 5.5 bln in the last twelve months ending March 2011, down 11% y/y. Although Fondul Proprietatea (FP) listing pushed up liquidity in the first three

Sales non-residents

Net Purchases non-residents

-100 -200

Source: BSE, BRD-GSG

Investment activity on BSE (residents), Shares segment, Regulated market

Purchases residents RONm 800 700 600 500 400 300 200 100 0 -100Dec-08 Mar-09 -200 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Sales residents Net Purchases residents

months of the year, it did not compensate the low volumes traded in the second half of 2010. Peers comparison: In the following paragraph we have tried to position the Romanian stock exchange among its peer countries, and to see how its evolution has been. First of all, we believe one of the most eloquent indicators of the development degree exhibited by a stock exchange could be found by analyzing the total market capitalization figures. As illustrated in the left table, it is clear that Romania lags behind the neighboring countries. The
2010 5.51 55.03 20.62 136.52 23.89 7.03 3.11 35.96 CAGR -7% 16% 24% 46% 43% -9% -11% 30%

Source: BSE, BRD-GSG

Peers comparison market capitalization 2008 2010

Market capitalization (end of period prices) EUR bln 2008 2009 Bulgaria 6.37 6.05 Czech Republic 41.00 49.00 Hungary 13.33 20.89 Poland 64.10 102.39 Romania 11.63 19.05 Slovenia 8.47 8.46 Slovakia 3.88 3.55 Average 21.25 29.91

discrepancy stems mainly from the fact that the other states have already privatized many of their companies through the equity market, while we have failed to implement successfully such listings until now. A brief comparison shows that as of the end of 2010, Romania had a total capitalization of EUR 23.9 bln, 5.7 times lower than Poland, while the market capitalization of selected peers average reached EUR 35.96 bln. However,

Source: BSE, BRD-GSG calculations

Peers comparison market capitalization 2008 2010 (as % of GDP)

M a r k e t c a p it a liz a t io n ( % o f G D P ) 2008 2009 B u lg a r ia 1 7 .9 9 1 7 .2 6 C e h ia 2 7 .7 2 3 5 .7 2 U n g a r ia 1 2 .5 3 2 2 .4 8 P o lo n ia 1 7 .6 5 3 2 .9 8 R o m a n ia 8 .3 2 1 6 .4 4 S lo v e n ia 2 2 .7 0 2 3 .9 1 S lo v a c ia 5 .9 9 5 .6 0 A v e ra g e 1 6 .1 3 2 2 .0 6 2010 1 5 .3 0 3 7 .7 0 2 0 .9 5 3 8 .6 0 1 9 .5 9 1 9 .4 9 4 .7 1 2 2 .3 4

our market capitalization CAGR 2008-2010 was 43% since the record low from 2008, outpacing peers average of 30% (in fact only Poland had a higher CAGR in the last two years), confirming Romanias potential. In terms of capitalization to GDP ratio, Romania also lags behind its peers, but is approaching its peers average, posting a ratio of 19.6% at the end of 2010. Poland and Czech Republic ranks on first and second place, respectively with 38.6% and 37.7%, respectively, while the peers average stands at 22.34% as of end-2010. The above figures suggest an upside

Source: BSE, BRD-GSG calculations

ROMANIA Economic Outlook Page 31 of 38

potential for our market which could be exploited in case the long-awaited state-owned companys listings will finally materialize.
Peers comparison market turnover
EURbn 70.0 66.5 58.6



Another important feature of the stock exchange is represented by the total turnover. On the left side we have illustrated the yearly liquidity in absolute terms, and it should come as no surprise that our market is again in the second half of the top. Of course, capitalization and liquidity go hand in hand, so for example Romania had a yearly turnover of EUR 1.3 bln in 2010, compared with peers average of EUR 16.2 bln. The discrepancy between us and the average is even higher in this case compared to the capitalization parameters, due to a lower average free-float exhibited by BET components. In terms of company fundamentals, a suitable comparison would be based on the P/E multiple, and our calculations point to an average of 10.0x for the 2011 P/E multiple within our peer group. According to this multiple, Romania trades at a 2.4% premium to its peers, as Q111 rally shaded the potential upside of local market.


50.0 42.8 40.0 38.0 34.6 39.7 32.0

30.0 20.9 20.0 17.518.5 21.1 15.4


4.2 4.3


1.9 1.1 1.0 2008 Hungary

1.2 0.4 0.7 2009 Romania Bulgaria

1.3 0.5 0.5 2010 Slovenia

2007 Poland Czech Republic

Source: Stock exchanges websites, BRD-GSG calculations

Peers comparison PER 2010/ 2011e (prices as of 30 Apr11)

16.00x 14.00x 12.00x 10.00x 8.00x 6.00x 4.00x 2.00x 0.00x P/E 2010 Czech Rep Poland Rom ania P/E 2011 Hungary Russia
8.04x 6.99x 13.88x 12.48x 12.81x12.15x 11.81x 11.13x 10.27x 10.17x

An interesting characteristic of the last periods evolutions stands in the correlation between the specific indexes. We have included below two correlation matrices corresponding to each of the years of our analyzed interval (Apr10 Apr11 and Apr09 Apr10). As it can be seen from the two sets of data, Romania has exhibited a moderate correlation with the other countries. The correlation changes between the analyzed periods are minimal as amplitude and had different directions. Thus in the last year (Apr10 Apr11) the correlation with CECE (the composite index including the most important companies listed in Poland, Czech Republic and Hungary) slightly decreased from 0.61 to 0.59, while the correlation with Euro Stoxx (including bluechips of Eurozone) increased from 0.50 to 0.55. Considering the y/y return in EUR, it appears that BSE has slightly outperformed our neighboring stock exchanges, with an annual increase of 8.1% compared to 6.9% registered by the CECE index of companies from Poland, Czech Republic and Hungary.
Correlation matrix (2010 2011)
Austria CECE Overall Fixed Romania_BET (1) (Rebased) WIG 20 (PL) (Rebased) PX 50 (CZ) (Rebased) BUX (HU) (Rebased) Euro Stoxx (Rebased) Austria CECE Overall 1.00 0.59 0.91 0.84 0.77 0.81 1.00 0.47 0.60 0.56 0.55 1.00 0.70 0.63 0.72 1.00 0.65 0.73 1.00 0.72 1.00 Romania_ BET (1) WIG 20 (PL) PX 50 (CZ) BUX (HU) Euro Stoxx (Rebased) (Rebased) (Rebased) (Rebased) (Rebased)

Source: Factset, BRD-GSG calculations

Correlation matrix (2009 2010)

Austria CECE Overall Fixed Romania_BET (1) (Rebased) WIG 20 (PL) (Rebased) PX 50 (CZ) (Rebased) BUX (HU) (Rebased) Euro Stoxx (Rebased) Austria Romania_B CECE ET (1) WIG 20 (PL) PX 50 (CZ) BUX (HU) Overall Fixed (Rebased) (Rebased) (Rebased) (Rebased) 1.00 0.61 0.91 0.79 0.79 0.76 1.00 0.53 0.53 0.47 0.50 1.00 0.63 0.65 0.70 1.00 0.63 0.52 1.00 0.64 1.00 Euro Stoxx (Rebased)

Source: Factset, BRD GSG

Source: Factset, BRD GSG

ROMANIA Economic Outlook Page 32 of 38

Legislation updates: Since our previous Romanian Economic Outlook released on October10, there were no major changes of capital markets regulations. In January11, the representatives of the two Romanian stock exchanges, i.e. Bucharest Stock Exchange and Sibiu Monetary Financial and Commodities Exchange have met with the representatives of their main minority shareholders, i.e. the five investments funds (SIFs) and have recommenced the discussion regarding the merger of the two operators. The plans of a merger between the two stock exchanges were abandoned in 2006 as the parties did not agree upon the price. However, the parties agreed that a merger would favor Romanian capital market development and will bring cost cuts and business consolidation for the two market operators. The merger between the two stock exchanges might end during this year, if the shareholders approve it and agree upon the financial terms.

Listings in 2011-2012: In 2011, the Government intends to launch a secondary public offering for OMV Petrom, Transelectrica and Transgaz shares, whilst the IPO for Romgaz is planned to be in 2012. On 4 August10, the Government decided to sell 9.84% of OMV Petrom (SNP) and 15% each of Transelectrica (TEL), Transgaz (TGN) and Romgaz through a selling public offering. The process of selling these stakes might last at least 4 months for Transelectrica and Transgaz and 8 months for Romgaz, respectively. In March 2011, Transelectrica and Transgaz proposed to the Ministry of Economy to increase the companies share capital by launching an IPO simultaneously or after the Governments SPOs. Thus, Transelectrica plans to raise its share capital by 10% 12%, and, additionally, to sell 15% of the states stake, whilst Transgaz proposed a 10% share capital increase. The plan to sell more shares in Transelectrica and in Transgaz needs government approval, who would still remain the majority shareholder with over 50%. On 4 November10, the shareholders of Electromagnetica Bucuresti (ELMA) approved within the Extraordinary Shareholders General Meeting, inter alia, the transfer of company's shares from RASDAQ to the BSEs platform. Another company that is going to be transferred to the BSEs platform is Perla Covasnei (PELA), a Rasdaq listed company acting in the manufacture of mineral water and soft drinks based on the shareholders approval within the EGM held on 9 November10. New Europe Property Investment Fund (NEPI), a SouthAfrican real estate investment fund plans to be listed on BSE during this year. The listing will be

ROMANIA Economic Outlook Page 33 of 38

a technical one, without a pre IPO. The fund will be the first one listed to BSE on the special segment for real estate vehicles, REIT. The fund is also listed on Johannesburg Stock Exchange and London Stock Exchange AIM section. Raiffeisen Centrobank is going to quote 13 structured products with FP shares as underlying assets on Vienna, Stuttgart and Frankfurt stock exchange. The 13 structured products would consist of: three turbo certificates, two discount certificates and eight warrants. The structured products target to raise volatility of FP shares on BSE, according to Raiffeisens representatives.

Changes in index composition: On March 4, 2011, the BSE Index Committee decided, at his quarterly meeting, to adjust all BSE indices (except BET-NG left unchanged) to reflect Fondul Proprietatea shares listing on BSE. The following changes were: BET index: Fondul Proprietatea (FP) and Bursa de Valori Bucuresti (BVB) substituted Condmag (COMI) and Dafora (DAFR) stocks. BET-FI index: Fondul Proprietatea (FP) was included; BET-XT index: Fondul Proprietatea (FP), Bursa de Valori Bucuresti (BVB) Ropharma (RPH) and Socep (SOCP) substituted Flamingo International (FLA), Rompetrol Well Services (PTR), Alro (ALR) and Turbomecanica (TBM) stocks. The weight of each company in BSE indices baskets was calculated based on the closing prices of 16 March 2011. The new BSE indices composition entered into force starting 21 March 2011.,

ROMANIA Economic Outlook Page 34 of 38

appetite environment

III.5.Banking sector Seeking profits in a low borrowing

The second year of economic contraction took its toll on 2010 banks business volumes and profitability, as: non-governmental loans declined by 3% y/y, real terms; total deposits reduced by 2% y/y, real terms, and the overall banking system posted a loss of RON 304m (EUR 72m) for the first time since 1999. The deterioration of loans quality was a major concern for all the banks, following the austerity measures taken by the Government in July10 and a delayed economic recovery. Thus, total doubtful and loss un-adjusted exposure reached 20.81% of total un-adjusted exposure of banking system as of end-Dec10, compared with 17.81% as of end-Jun10 and 15.29% as of end-Dec09, respectively. Provisions creation process continued in 2010, but at a slower monthly pace in the last three months of the year and we dont believe we saw the end of it, because of the factors stated below. However, the financial stability of the domestic banking system hasnt
Dec'10 Solvency ratio (>8%) * Tier 1 equity / Total average assets General risk ratio Liquidity ratio
Source: NBR

Key Prudential Indicators:

Sep'09 14.59% 7.89% 46.27% 1.38 14.66% 7.87% 44.56% 1.36

weakened (solvency ratio has been kept above 14% during the year, far beyond the 8% minimum requirement of NBR, respectively the 10% under Vienna agreement), underlining the good capitalization of banks and good capacity to withstand with a potential deterioration in banks assets. NBR pursued a cautiously supervision, requesting local banks, which did not meet solvability criteria, to increase share capital and bring solvability ratios above 10%. Given the easing on financial stability risks, the Vienna agreement ended on 16 March 2011, but all the partners assured that will secure a CAR (Capital Adequacy Ratio) above 10%. For 2011, major challenge remains non-governmental loans real growth resumption, as a GDP real growth of 1.5% y/y for 2011 should not be enough to lead to a significant two-digit increase in non-governmental loans. Thus, in 2011 we expect non-governmental loans to expand by 5.2% y/y (vs. +4.7% y/y in 2010), nominal terms, supported mostly by corporate sector. The non-governmental loans growth might double up to 10.8% y/y, nominal terms, in 2012. On deposits side, we dont estimate any significant change in households savings pattern in 2011, whilst the corporate segment is expected to use all its resources for mediumlong term growth. Thus, we expect deposits to rise by 6.4% y/y, nominal terms, in 2011 and by 10% y/y, nominal terms for 2012, respectively.

Non-governmental loans driven up by corporate sector

BRD-GS G es timate s 10 0% 25 %

28. 8%

2 8. 9%

2 9.5 %

29 .4 %

30 .1%

31 .1%

3 1.1 %

3 1.4 %

31 .9%

31 .9%

20 %


15 % 30. 2% 3 0. 3% 3 0.2 % 30 .7 % 30 .3% 3 2. 1% 32 .1% 10 .8 % 5 .2 % 20 .5 % 20 .6% 19 .4% 1 9.6 % 1 9.8 % 19 .3% 19 .3% 0% 19. 8% 2 0. 0% 1 9.8 % 19 .4 % 19 .0% 17 .8% 1 7.9 % 1 7.2 % 16 .7% 16 .7% - 5% Ma r- 09 Jun -0 9 Se p- 09 De c-0 9 M ar -1 0 Ju n- 10 S ep- 1 0 Dec- 10 De c-1 1e De c-1 2e 5% 10 %

5 0%

31 .6%

3 1.4 %

3 1.6 %

21. 2% R ON

2 0. 9%

2 0.5 %


Ho useh old s' loa ns in R ON Ho useh old s' loa ns in F CY No n- gove r nm ent al loan s ( yoy cha nge , n om ina l t er ms) , r hs

Non - fina ncia l inst itu tion s+ NM FI loa ns in R ON Non - fina ncia l inst itu tion s+ NM FI loa ns in FC Y

Source: NBR, BRD-GSG forecast

ROMANIA Economic Outlook Page 35 of 38

We anticipate provisions stock to increase by 21.8% y/y in 2011 (vs.

100 .0% 15.8% FCY 21.3% 20.9% 21.8 % 22.7 % 22.6% 2 3.8% 23.1% 22.4% 21.9% 21 .9% 10 % .0 50.0% 25.7% 26.4% 25.7 % 25.9 % 25.8% 2 5.5% 26.4% 27.8% 28.3% 10% 28.3% 8% 6.4% 38.0% 6% 4% 2% 0.0% M ar-09 Ju -09 n Sep -09 D ec-09 M ar-10 J -10 un S -10 ep Dec-1 0 D ec-11e Dec-12 e 0% 14.7% 16.0 % 16.1 % 14.5% 1 4.2% 14.2% 13.6% BR -G Gestim tes D S a 13.1% 13 .1% 18% 16% 14% 12%

57.4% y/y in 2010), leading the coverage ratio to 57% in 2011 vs. 56% in 2010. In our opinion, main factors leading to this evolution are: 1) higher pressure for provisions stemming from deterioration of loans classified currently as 60 days overdue; 2) reevaluation of guarantees at lower prices given the downward adjustments of assets prices. The law states that banks should revaluate their guarantees once at three years. Thus, if the last reevaluation was done in 2008 (very likely), then 2011 should bring some adjustments to guarantees revaluation which might trigger further need for provisions to be made. Certainly, some reevaluations were done in 2010, too, but the adjusted non-governmental exposure increased faster than unadjusted non-governmental exposure on monthly basis showing that

RON 37.2% 36.5 % 35.3 % 37.1% 3 6.5% 36.2% 36.2%


36 .7%

H seh s' dep ou old osits RON H seh s' dep ou old osits FCY T domestic dep otal osits (yoychan nomin term rhs ge, al s),

Non-finan in tion N FIdep cial stitu s+ M osits RON Non-finan in tion N FIdep ts FCY cial stitu s'+ M osi

Source: NBR, BRD-GSG forecast

Undajusted exposure vs. adjusted exposure

Bn R ON 210.00 12.00% 10.00% 160.00 8.00% 6.00% 110.00 4.00% 2.00% 0.00% 60.00 -2.00% -4.00% 10.00 J -09 an -40.00 Total non-governm tal exposu ( adjusted) en re un Total non-governm tal exposu ( sted) en re adju Total non-governm tal exposu ( adjusted) ch m-o-m en re un ,rhs Total non-governm tal exposu ( sted) ch m-o-m,rh en re adju s Apr-09 J ul-09 Oct-09 J -10 an A pr-10 Ju l-10 Oct-10 Jan-11 -6.00% -8.00% -10.00%

guarantees were valued to lower prices. Additionally to provisions creation, in 2011 there is another risk to be tackled by banks, namely recovery process of non-performing loans and management of those which are off-balanced items, especially that a coverage ratio of 56% in 2010 is quite low. Interest rates are driven by opposite forces: the need to lower costs vs. inflationary pressures. Lower loans costs cant by themselves resume lending activity, but it is a requirement for improving banks business volumes. This combined with lower or unchanged costs of funding for banks should increase banks profits, damaged by deterioration in loans quality. As regards costs of funding, whether RON or FCY denominated, we dont see any pressure for an upward evolution for 2011, as a major financing gap is less likely for this year (total loans -domestic&foreign- to total deposits -

Source: NBR, BRD-GSG calculations

Spread rates for old loans-deposits

9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Jan -09

domestic&foreign- is below 1). This in conjunction with improved investors

sentiment for domestic market in the past months reflected in CDS decline, should offset, to some extent, higher benchmark rates for FCY denominated
Apr-09 Jul-09 O ct-09 Jan -10 Apr-10 Jul-10 O ct-10 Ja n-11

funds (mainly in EUR) due to tighter monetary conditions given inflationary risks in Eurozone. Naturally, the active interest rates are influenced by benchmark rates and by debtors creditworthiness evolution. Households credibility will lag behind non-financial institutions once economic recovery is underway. Still, we see lower rates for RON denominated loans as banks are compelled, under the current environment, to prompt lending activity. EUR active interest rates might increase slightly following higher benchmark rates, especially for

RO indiv uals N id E individ UR uals

RO non N -finan in cial stitutio ns EU non-financial institution R s

Source: NBR, BRD-GSG calculations

ROMANIA Economic Outlook Page 36 of 38

Spread rates for new loans-deposits

8 % 7 % 6 % 5 % 4 % 3 % 2 % 1 % 0 % Ja 09 nAp 9 r-0 J 9 ul-0 O 9 ct-0 Ja 0 n-1 Apr -10 Ju l-10 Oct-10 Jan -11

households segment as the Ordinance no. 50 provisions state to link new retail loans to a benchmark rate. Thus, in 2011 we expect RON new loans-deposits interest rate spread to continue to decline by a smaller pace compared with 2010, approx. 120 bps, from the 2010 average of 5.1%/5.2% for individuals/corporate sector, whilst EUR new loans-deposits rate spread to post a slightly upward evolution, no more than 50-100 bps, from the 2010 average of 3.1%/3.3% for individuals/corporate sector. We reiterate our view for a slowly downward adjustment (if any) of interest rates spread for old loans-deposits, primarily, due to their original settings. Consequently, given all the above mentioned, with a slight increase of loans and mild improvement of the net interest income, we might see a small profit for the overall banking system, with some banks ending 2011 in red.

RO in als N dividu EU in idu R div als

RO no fina l in tio N n- ncia stitu ns E Rno ncial institu ns U n-fina tio

Source: NBR, BRD-GSG calculations,

ROMANIA Economic Outlook Page 37 of 38

IV.Forecast: Main Macroeconomic Indicators

Main Macroeconomic Indicators
2008 Nominal GDP Nominal GDP GDP Private consumption Government consumption Gross Fixed Capital Formation Agriculture, forestry and fishing Industry Construction Wholesale and retail; Financial services Other services Unemployment CPI CPI Fiscal gap Key interest rate RON bn EUR bn real, y/y real, y/y real, y/y real, y/y real, y/y real, y/y real, y/y real, y/y real, y/y real, y/y yoy eop avg % GDP eop 515 140 7.3% 5.1% 7.1% 16.1% 21.9% 1.9% 26.1% 8.2% 5.3% 0.7% 4.4% 6.3% 7.9% -4.8% 10.25% 2009 491 116 -7.1% -12.4% 0.8% -25.3% -0.4% -4.3% -13.6% -11.3% -5.8% -0.3% 7.8% 4.7% 5.7% -7.4% 8.00% 2010 513 122 -1.3% 2.1% -3.2% -13.1% -0.8% 5.1% -10.7% -4.0% 0.8% -2.8% 6.9% 8.0% 6.1% -6.5% 6.25% 2011(f) 545 133 1.5% 2.0% -1.5% 0.0% 5.0% 3.0% 0.0% 1.5% 1.5% -2.0% 7.5% 4.9% 6.5% -4.4% 5.75% 2012(f) 595 147 3.0% 2.5% -0.5% 10.0% 10.0% 2.8% 5.0% 3.5% 2.0% 0.0% 7.0% 3.5% 3.8% -3.0% 4.5%

Exchange rate EUR/USD* Exchange rate EUR/RON Exchange rate EUR/RON Exchange rate USD/RON Exchange rate USD/RON Current account balance Current account balance Foreign Trade Balance (FOB/FOB) Foreign Trade Balance (FOB/FOB) Exports Imports Net FDI flows

eop avg eop avg eop EUR bn % GDP EUR bn % GDP nominal, y/y, EUR-den nominal, y/y, EUR-den EUR bn

1.41 3.69 3.99 2.52 2.83 -16.2 -11.6% -18.5 -13.3% 16.4% 13.3% 9.0

1.44 4.24 4.23 3.05 2.94 -4.9 -4.2% -7.2 -6.2% -14.9% -28.9% 4.9

1.33 4.21 4.28 3.24 3.21 -5.0 -4.1% -6.5 -5.3% 21.2% 16.2% 2.5

1.5 4.10 4.05 2.97 2.70 -5.7 -4.3% -7.4 -5.6% 21.0% 20.0% 3.5

n/a 4.05 4.00 n/a n/a -6.6 -4.5% -8.4 -5.7% 22.0% 21.0% 4.5

*SGCIB estimates BRD-GSG forecasts

ROMANIA Economic Outlook Page 38 of 38

BRD-GSG - Research
Florian LIBOCOR Carmen LIPAR Monica NANIA Laura SIMION, CFA Razvan PANURU Chief Economist Head of Research Head of Financial Markets Research Economist Equity Analyst Junior Analyst

+40 21 301 6850 +40 21 301 6869 +40 21 301 4370 +40 21 301 6858 +40 21 301 4461 +40 21 301 4337

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