BR ANALYSIS. Taxing times: Romanian entrepreneurs brace for big challenges

Romanian businesspeople face major challenges in 2019 as the economic environment is changed by new or higher taxes, decelerating consumer spending, higher borrowing costs, a weaker currency and higher wages. All these challenges could translate into steeper costs and unpredictable revenues.

By Sorin Melenciuc

Higher taxes, new taxes

Running out of revenue sources, the government recently introduced a 0.3 percent tax on bank assets, effective January 1, 2019, and capped retail and corporate gas prices at RON 68/Mwh.

It also imposed special taxes of 2 percent of turnover on energy firms and 3 percent on telecom companies.

The government has not yet released a draft budget for 2019 and many experts say it has no money to finance its soaring spending on public servants’ wages and pensions.

Experts also warn that Romania is facing a testing end of the business and election cycles in 2019, and this means major challenges for local entrepreneurs.

The CNIPMMR, an organization of Romanian SMEs, is expecting a major impact from the new taxes and warns that many company owners are thinking seriously about moving their businesses abroad to avoid spiraling costs.

“Our colleagues asked us to look at a potential meeting with SME organizations in Bulgaria and to initiate a dialogue on the possibility of moving some activities from Romania, because many entrepreneurs now feel that things are not moving in a good direction,” said CNIPMMR president Florin Jianu.

Many business owners and analysts expect new taxes or “ad-hoc tax hikes” this year due to the major fiscal difficulties facing the government.

There are already suggestions in the market that the government might raise income tax on higher revenues or introduce other taxes to finance its soaring social spending.

“Exogenous factors, such as ad-hoc tax hikes and gradual RON depreciation (…) would add to inflation, while imported inflation and a higher EUR-USD rate may lower it,” Dan Bucsa, chief CEE economist at UniCredit in London, said in a recent report.

Rising borrowing costs

Inflation, as always, puts pressure on borrowing costs, as the interest rate is mainly insurance against currency depreciation through price increases.

Central bank data seen by Business Review show that interest rates were already on a rising trend last year.

In November 2018, the average interest rate for new RON loans granted by Romanian banks to non-financial companies was 6.12 percent per annum, compared to 6.06 percent in October, 5.88 percent in September and 4.69 percent in November 2017.

Economists now expect this trend to accelerate in 2019 due mainly to rising inflation, RON depreciation, the new tax on banks’ assets – which will be passed on one way or another to customers – and to higher risks associated with businesses and the value of guarantees.

“Ceteris paribus, the tax measures (of the government) will lead to a process of bank disintermediation and an increase in risk margins, which cannot remain without effect on the prospects for economic growth, especially against the backdrop of the slowdown of the global and European economies,” Horia Braun-Erdei, chief economist at BCR, said in a recent report.

The economists expect a rapid deceleration of the credit growth rate – of up to 2-3 percent, in a moderate scenario – this year, due to the new fiscal measures, with a major impact on investment in Romania.

Weaker RON

One of the main risks to have already materialized in 2019 is the depreciation of the Romanian currency. Following the announcement of the new fiscal measures, most economists expected the RON to lose around 2-3 percent of its value over the entire 2019 but the reality seems much worse.

In the first three weeks of the year, the RON had already lost 2 percent of its value against the European single currency and the central bank seems to accept this trend as an inevitable correction of Romania’s major economic imbalances.

The Romanian central bank has warned that the RON is being hit mainly by the country’s lack of credibility.

“There are many elements here – we have a background situation, one of conjuncture and a momentary one. All three contributed to the result, namely: a lack of credibility for investors holding RON and who are starting to let go of their holdings. That is where the pressure is coming from. Let’s remember that the RON is a convertible currency. (…) Thus, the credibility of the local situation is extremely important in setting expectations. The lack of credibility is really what worries us more than anything else,” said central bank spokesman Dan Suciu.

Some analysts have already changed their forecasts and now expect the RON to fall to unprecedented exchange rates.

Liam Carson, an analyst from the macroeconomic research firm Capital Economics, expects the exchange rate to reach over RON 5/EUR.

“The size of Romania’s current account deficit suggests that the RON is overvalued. The central bank intervened throughout most of 2018 to prevent depreciation, but that’s ultimately unsustainable,” Carson said.

Many economists warn that the RON is also being weakened by the new tax on bank assets, as it is correlated with the money market rates – the higher the rates, the higher the tax.

Central banks use interest rates as a prime tool to defend a currency – the higher the interest rate, the lower the risk of depreciation, as the currency becomes more attractive as an investment if it offers higher returns.

But the new tax on assets reduces the Romanian central bank’s incentive to use interest rates to defend the RON, as higher interest rates risk reducing the solvency of the local banking system.

A weaker RON has the potential to hit high numbers of businesses in Romania as many costs in the country are calculated in EUR – from mobile bills to real estate.

Many suppliers also calculate their prices in EUR and so depreciation of the RON could see local prices spike.

Businesses that import goods or services from abroad will also be hit by a severe depreciation – while, on the other hand, exporters will largely benefit from the depreciation of the RON.

Weaker consumer demand and investment

Another major challenge for local businesses is the slowdown of consumer demand following years of government wage-led growth policies which boosted consumer spending.

Until 2017, consumer demand had been posting two-digit growth rates, but last year the first signs of deceleration appeared as consumer spending rose by only around 6 percent, according to the latest forecasts.

This trend will accelerate further in 2019 as most analysts expect the consumer demand growth rate to slow to maximum 4 percent.

“Despite the government’s ambitious plan to increase wages and pensions before the elections, private consumption growth is likely to slow. A worsening outlook for exporters will dampen wage indexation in the private sector,” UniCredit analysts predict.

But against this background, some businesses will be more affected than others as the government has chosen to apply new taxes only in some sectors.

In energy and telecom, new taxes could put pressure on production, investment and employment.

A Romanian oil industry association has already warned that companies in the sector are preparing to reduce production and investment, and freeze employment.

In telecom, some analysts expect a delay in the introduction of 5G in Romania due to higher taxes.

Banks are also taking cost-saving measures with a possible impact on many businesses.

“We will reduce investment, train fewer people. (…) Banca Transilvania was planning to renovate over 200 branches. That means dozens of construction firms will not get these contracts,” Banca Transilvania CEO Omer Tetik said in a press conference.

A significant impact can be expected in the construction sector as the government has introduced a higher minimum guaranteed wage of RON 3,000 for employees of construction companies and their suppliers.

In this sector, a second major impact could come from lower public and private investment.

“Investment could fall further in 2019-20 after the financial conditions tightened significantly in 2018 due to higher interest rates and credit constraints imposed by the central bank. As a result, building output is likely to rise at a slower pace and could be completely offset by a further drop in infrastructure works,” UniCredit analysts warn.

Unpredictable economy

“In 2019, Romania will be like a tightrope walker whose safety net has begun to split. Any increase in the wind will become a threat to him, and he risks an economic and financial accident,” said Braun-Erdei of Romania’s situation.

For many analysts and entrepreneurs, it is difficult to predict the real impact of all these new measures on the business environment or the economy as a whole.

These uncertainties may be exacerbated by possible political turbulence associated with the two rounds of elections this year and another two in 2020.

Analysts have already begun to significantly cut their GDP growth forecasts in Romania this year following the introduction of the new taxes.

Banca Transilvania analysts recently announced that they have cut their forecast to 2.8 percent for 2019, and other economists also expect GDP growth rates of close to 3 percent.

But some analysts are already warning about the possibility of a recession in Romania. “Factoring in the contractionary impact of the tax package, as well as external and domestic risks, a technical recession in 2020 cannot be ruled out,” UniCredit economist Dan Bucsa cautioned.

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