Emergency Ordinance (OUG) 114/2018 changes the rules in sectors that support both the economy and the population’s quality of life: energy, telecommunications, financial-banking, capital market. The introduction of unjustified taxes in these sectors risks pushing them into a deep crisis. The business leaders that the Coalition for Romania’s Development (CDR) represents, who are both Romanians and foreigners, wrote an open letter to the prime minister asking her to cancel the OUG.
As a result of extensive discussions with prominent economists and leading business leaders, the CDR points out that it is possible that, following OUG 114, access to finance will become more difficult in Romania; SMEs can be significantly affected; revenues and consumption may drop; citizens will have difficulty accessing bank credit; macroeconomic imbalances will increase; the capital market will play an even smaller role in financing the economy; the RON may depreciate against other currencies; the state risks paying higher interest rates for financing its deficit.
In the absence of any dialogue and the long list of adverse consequences they anticipate, the CDR is asking the government to abrogate the Emergency Ordinance before it produces negative effects. “We express our availability for meetings to explain our analysis in detail,” they wrote.
“The decision of the Romanian government to adopt OUG 114/2018 in the last days of the year, without consulting with the affected business environment and industries and without an impact study, was a continuation of a frequent practice. It is not the first time the business environment is not consulted and not even warned in advance of measures with significant consequences,” the CDR added.
The organisation continues to say that “the continued, severe and unpredictable intervention of the government in the legislative framework only makes it harder for business and has a serious potential to discourage investment.”
“According to the calculations of the National Bank of Romania, it is very likely that most banks in Romania will record losses in the coming years, which can only mean a restriction of credit nationally, while the financial intermediation in Romania is one of the lowest in Europe, and funding in Romania is significantly dependent on the banking system.
If large companies are most likely to find cross-border financing solutions from financial institutions abroad or through equity markets, making access to finance more difficult will have the greatest negative impact on consumers (especially in terms of mortgage lending) and small companies. Moreover, unregulated and non-taxed funding will be encouraged.
According to the Impact Assessment carried out by the Financial Supervisory Authority, the exaggerated conditions imposed on the pension fund managers are another way of expressing the government’s wish that they should leave Romania. They are subject to capital requirements that are completely unjustified and at a considerable distance from any proper European practice. For telecommunications and energy, regulated prices, sales restrictions and new taxes or contributions risk bankrupting small players on the market reduce the margins of large players to such an extent that they will be forced to take measures to limit their exposure to rising costs and reduce investment.”
The CDR’s letter continues with a breakdown of the OUG’s effects on each of the sectors it targets:
The introduction of a bank asset tax, disproportionate to the size of the system and its reporting on the ROBOR index, is a factor that will cause confusion and damage the country’s status as a market economy. The ROBOR increase is mainly caused by inflation, budget deficit, and government policies – not by banks. In addition, even if the taxation of financial assets of banks is not related to the ROBOR, its current level (about 1.2 percent per annum) exceeds any other similar tax in Europe. The tax will be applied to an asset base that includes cash, required reserves deposited with the National Bank and government bonds, a unique provision in the EU or worldwide as far as we are aware.
The inclusion of state bonds in the tax base distorts competition for local banks that hold government securities against non-resident or any other non-resident holder. The current tax rate is three times the return on assets recorded by banks over the past 10 years – 0.44 percent. Other countries that introduced a similar tax had the incentive to recover extra funds used by the state to rescue troubled banks after the 2008 financial crisis, which is not the case in Romania. On the contrary, the level of investments made in Romania by foreign banks amounts to billions of euros.
Essentially, such a tax should be aimed at mitigating the risk in the banking system because otherwise the consequences of its imposition may be drastic: a cash-based economy, significantly reduced investment, and increased government borrowing costs. Hungary had to substantially reduce its tax rate over the past 2 years due to these insufficiently taken into account consequences.
From the impact study conducted by the National Bank of Romania, in the adverse scenario, in just two years, 27 banks, including all systemic banks, would no longer have sufficient funds to fully meet the global capital requirements imposed by European legislation. The 27 banks will have to ask shareholders in 2020 for an additional capital injection of at least several billion euros. The BNR also recommended that it would be useful to include in the substantiation of the tax proposal on the bank asset tax and the costs that the authorities might have to pay to save the banks. Romania has the lowest degree of financial intermediation in the EU (26.4 percent), the lowest number of SMEs per thousand inhabitants (43), the lowest degree of digitization and consequently an increased need for financing loans).
Given that this tax will swallow up the entire banking system, credit institutions in Romania will not have the resources to invest in infrastructure development and financial education so that our country can recover the gap with the EU.
Pension Pillar II
From the impact analysis carried out by the ASF, private pension fund managers are subject to completely unreasonable additional capital requirements without any substantiation of the risks that should be covered by this additional capital. The managers of the seven private pension funds will have to increase their equity by about EUR 800 million in 2019 alone, i.e. 11 times more than today, and twice as much as all gross fees received by all Pillar II administrators in the 11 years of the system’s operation. The government has not provided any justification for imposing such stringent capital requirements in parallel with the reduction of the permissible administration fee by up to 70 percent.
In simple words, administrators will have to bring home EUR 800 million in a situation where lowering fees, however small compared to the EU average, will no longer allow them to make profits. It is an unwritten invitation for these companies to leave, with hard to anticipate effects, is a de facto nationalization of the system. “The high level of minimum capital, coupled with the short-term compliance (related to the amount of input needed), may discourage the management of privately managed pension funds, with the risk that some administrators may not be able to obtain the necessary resources and be forced to withdraw,” according to the ASF. The Bucharest Stock Exchange will receive a catastrophic blow and the objective of increasing the financing of the Romanian economy through the capital market will be impossible to achieve in the medium and long term. Last but not least, eliminating this domestic saving mechanism will also increase the cost of financing and refinancing public debt and increasing dependency on foreign capital flows, usually more volatile, in a country where demographic developments (aging population and emigration) will have serious effects on both the budget and the standard of living of citizens.
In the telecommunications sector, the government has decided to increase the monitoring tariff from a maximum of 0.4 percent to 3 percent of the turnover, a toll which is excessive and unjustified, as well as contrary to the European and national regulatory framework, and will become a burden for the entire Romanian telecoms industry and for all fixed and mobile Internet users, fixed and mobile telephony and television services and which will lead to blocking the development of electronic communications networks and services. In line with the European provisions, this tax should only cover the amount of administrative costs incurred by the regulatory authority in carrying out the regulatory tasks assigned to it, and not result in a surcharge for the industry.
The thresholds set by OUG 114 for bidding for spectrum bids appear to be so high that they will discourage any significant investment in the future. OUG 114 also disfavours the electronic communications sector to other industries through the disproportion between the low social danger of the deeds referred to in Article 85 (on the sanctioning regime of telecommunications infrastructure works) and the amount of the sanction applied by those provisions. The provisions are also contradictory in relation to the authorization regime and add to a very bureaucratic process of endorsement and authorization. Maintaining these provisions will result in blocking investments in high-speed network building and in upgrading existing networks.
The prices for the acquisition of frequency spectra are exaggeratedly large and unrelated to the actual value, being randomly set in contradiction with the provisions of the European regulatory framework. Romania could boast globally with an internet speed that places us first, but this performance can only be sustained by constant investment. In the context in which Romania, including at the moment of taking over the presidency of the Council of the European Union, has assumed objectives such as the digitization of the economy and administration as national priorities, it is incomprehensible why the government opts for a punitive and discouraging tax regime in this area.
Telecommunication infrastructure, which is the foundation and catalyst for many other sectors, and progress towards an advanced digital economy is jeopardized by OUG 114. In this context, achieving the Digital Agenda for Europe goals for access to broadband communications services by 2020 and implementing “Action Plan: 5G for Europe” on the coordinated introduction of 5G services in the Union, including Romania, are in real danger.
In the energy sector, the situation is also worrying. This is a sector where, again, the investment needs are very high and the Romanian state does not have the resources needed to do it all in the next two decades. Decapitalization of the sector following this ordinance will further slow the pace of investment. Efforts to liberalize and deregulate the gas and electricity markets so far have been a significant step forward, despite some significant shortcomings that should have been addressed, but not the way OUG 114 does.
The Ordinance sets the wholesale price of natural gas in Romania at a level far below international prices, reintroduces sales obligations for gas producers, provides for ANRE to determine the proportion of imports / domestic production for the non-resident segment and introduces a 2% contribution to the regulator. These terms represent a severe government intervention on the Romanian energy market, abandoning the development of wholesale energy markets that have allowed national and international manufacturers and suppliers, importers and traders to compete in supplying Romanian consumers. These terms de facto reintroduce a centralized economy.
They are in strong conflict with the EU’s single market principles on free trade and the free movement of goods and will inevitably trigger procedures to penalize breaches of Community law.
OUG 114 discourages investment in natural gas production because producers will not be able to sell at prices that reflect international commodity raw materials. Over time, this will reduce the production of natural gas in Romania, its economic activity and related employment. OUG 114 also discriminates Romanian producers towards foreign ones, who will be able to sell without restrictions.
The Ordinance overturned the progress made in reforming the Romanian natural gas market: for example, fixed prices and ANRE contribution of 2 percent could prevent the activities of traders who usually operate with small margins. As a result, a liquidity development on centralized markets in Romania (which was a key justification for the centralized market obligation) is unlikely. Setting a much lower price for gas compared to European regional prices and setting up a gas basket could also be a state aid measure. In addition, these measures will generate significant losses to the state budget and possibly further losses due to reduced investment, lower gas production, job losses and negative economic impacts.
In this context, a contribution to the regulatory regulator of turnover in an industry that largely operates with large volumes and reduced margins can jeopardize returns to the point of cancellation of capital expenditure. The faulty mode in which the law was written and the increase of the fines create significant exposures in the event of non-compliance and, as a result, threaten the energy sector in a stalemate; transactions in the electricity and gas market have already shown signs of blocking with visible effects.
OUG 114 also stimulates market participants to buy gas from Romanian producers at fixed (low) prices and then export them. We anticipate a massive increase in natural gas exports in Romania, probably followed by substantial imports at a higher price to cover the needs of domestic consumption. The effects of this ordinance will be to reduce the supply of Romanian consumers, especially during periods of high demand in winter, which is the opposite of the intentions of the political decision-makers. OUG 114 limits fixed prices and sales obligations by February 2022. However, it will be difficult to move from a centralized planned and regulated market back into a competitive market environment.
In the electricity sector, the return to household price regulation just one year after liberalization creates an uncertain situation for those (about 2 million) who have opted for the free market. By granting preferential prices to regulated market customers, those customers in the open market will be disadvantaged in terms of prices and will probably consider a return to regulated prices.
In recent years, suppliers have invested heavily in developing the competitive market, relying on the timetable for liberalization and the explicit intention of creating a free market. By regulating a market segment, competition on the free market is adversely affected by price distortion, taking into account the withdrawal from the competitive market of a quantity of electricity to be sold at regulated prices and tariffs, and any costs associated with the sale of energy the regulated segment not recognized by ANRE or recognized late will be transferred to the competitive segment, thus presenting a subsidy for the segment regulated by the competitive one. Overnight, this market – the result of work for years with the Romanian authorities is jeopardized, with negative consequences for investments.
The capital market suffered significant losses immediately after the announcement of OUG 114/2018 and then in the coming weeks. The CDR considers that this fall in the stock exchange was determined unequivocally by the unexpected announcement of all these measures. This increased volatility will affect investor confidence just as BSE has made significant efforts to move from border market to emerging market, which could bring significant investment in Romania. Funds investing in emerging markets have management assets of about 130 times higher than those investing in border markets and which currently cannot invest in Romania.
Affected by Pillar 2 fund managers and banks (the financial sector being one of the most representative on the stock exchange) is felt to affect the local investor base to support public offerings through the capital market and the sustainable market liquidity, it has reduced liquidity and will continue to do so if these funds will have to withdraw. In the context of the fact that this OuG remains unchanged, the Romanian scholarship will remain considerably underdeveloped compared to other scholarships in the region.
In addition to the impact of affecting the local investor base, OUG has become even more affected by energy and telecoms measures that, together with the banking sector, are the main constituents of the benchmark indices of the local capital market BET. Any impairment of the sector in which the companies included in the index work is reflected in the price of the shares of these companies, reduces the assessment from the perspective of the decrease of the profitability and affects the medium and long term sustainable liquidity.
In addition, all this reduces the chances of new listings of Romanian private companies on the BVB, contrary to the European objective of reducing the dependence on companies financing through bank credit. We believe that the fall in stock market indices as a result of this OUG has dramatically affected investors’ confidence and therefore the decrease in the attractiveness of the investments will cancel Romania’s chances of promoting this year’s emerging market status despite all the efforts made over four years.
The construction sector is also negatively affected by the lack of clarity of the OUG 114, both in terms of legal formulations and in terms of its objectives for the sector. It is not clear who will benefit from the tax incentives in the ordinance and how the legislation is drafted will have an impact both on companies in other sectors that have small construction activities but also on construction personnel not directly involved in construction but dealing with various related activities.
Generally, manufacturers with significant turnover (more than EUR 1 million), with predictable financial behaviors, attractive from a banking perspective, have a turnover generated by several activities, not just construction. As a result, their economic sustainability and development potential are higher compared to other companies that have one type of activity. Setting the 80 percent turnover threshold will cause these companies to divide into smaller entities with lower turnover, diminishing their competitive banking capabilities for large infrastructure works. On the other hand, the high turnover ensures the competitiveness of the Romanian contractors in the large public sector offers due to the ability to provide financial guarantees up to the level required for large infrastructure works.
The 80 percent turnover threshold sets a very volatile limit, to be demonstrated monthly to tax authorities, to highlight the legitimate implementation of OUG 114; this will generate a great deal of bureaucratic work and increased costs, with a high risk of misinterpretation and misapplication, which would result in sanctions for the company.
All these measures come in a context in which the Romanian economy seems to have reached the peak of economic growth and is about to enter a more moderate growth period. Worse, there are enough signs that the forecasts for the European economy are rather cautious in the next period and we know that if the most important trading partner sneezes, Romania gets sick. Above all, there are concerns about the sustainability of public finances, especially since these end-of-year measures seem to bring funds to a state budget that is hard to cope with all public spending growth in recent years.
All these represent significant risks to Romania’s economy and their accumulation is not a good thing for the business environment, for the population nor for the state budget in the end. The robust macroeconomic figures obtained after the 2011-2015 restructuring and a strong global and European economy acted as a shield for some of the government’s measures that created imbalances in some private areas in Romania. This time, the measures introduced by OUG 114 bring about massive, structural changes that can have a serious impact on the whole economy with implications for every citizen. This arbitrary way of making decisions will become very corrosive as the clouds gather.