The new government has little room for manoeuvre in the economy in 2020 as two rounds of elections approach, but foreign investment – both direct and portfolio investments – could bring a boost to local activity.  On the other hand, the business environment faces almost no risk of sudden changes in fiscal policy in an electoral year.

By Sorin Melenciuc

In 2019, the Romanian economy grew by around 4 percent, a decent pace given the many challenges experienced last year due mainly to the former government’s policies. In fact, the local economy is now at the end of a decade-long growth cycle and faces the challenge of finding new drivers of development as the resources supporting wage-led growth policies have run out. At the end of this growth cycle, there are a lot of achievements to list, but plenty of red flags remain on the board as well.

Achievements

In 2019, Romania’s gross domestic product (GDP) was certainly close to EUR 220 billion, or more than EUR 11,000 per inhabitant, and the average wage rose to around EUR 650 per month. The unemployment rate is also at a three-decade low. It is still a low economic level compared to western European economies, but it is by far the highest ever achieved in the country’s history. From a regional perspective, Romania is now more developed than all of its neighbouring countries, with the exception of Hungary.

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In fact, in terms of GDP, Romania is by far the largest economy in its region, overtaking all of its neighbours – Romania’s GDP is as large as the GDPs of Hungary, Serbia and Bulgaria combined. At the same time, the differences between Romania and its more developed regional rivals, such as Hungary, Slovakia or Poland, have eroded during the last few years as the south-eastern European country has managed to maintain higher growth paces.

Another positive trend is a surge in investments last year. “The contribution of gross fixed capital formation has considerably exceeded that of household consumption, reaching an 11-year high, mainly on account of investments in new construction works, as well as the pick-up in equipment purchases, with a favourable impact on the economy’s future growth potential,” according to a recent Romanian central bank report. Foreign direct investment (FDI), a long-term source of capital for development, could be seen as a positive surprise of the last couple of years.

Official data show that FDI in Romania totalled EUR 5.15 billion in January-November 2019, compared to EUR 5.02 billion in the same period of 2018, “of which equity (including estimated net reinvestment of earnings) amounted to EUR 4.4 billion and intercompany lending recorded a net value of EUR 649 million,” the BNR writes.

This increase was “determined by an improvement of the perception of investment risk (after the European Parliamentary elections) and of the Romanian economy’s potential in the medium term (considered to be higher than the potential of other countries in the region),” Banca Transilvania analysts indicated in a research note. This means that FDI in Romania amounted to more than EUR 10 billion over two years, covering about half of the external deficit registered during the same period.

Following this new influx of foreign investment, the stock of FDI in Romania is very likely to reach the EUR 90 billion threshold in 2020. Official data show that foreign investors had made total direct investments worth EUR 83.8 billion Romania by the end of June 2019, an all-time high, up 7 percent (EUR 5.5 billion) against June 2018.

Much of this new investment was spent on real estate developments, as Romania’s big cities are experiencing urban regeneration and improvement. New residential compounds, brand new office towers and retail projects are under development in Bucharest, Cluj, Timisoara and Iasi, Romania’s biggest cities, and they are changing the country’s image.

Red flags

But all these achievements have come at a cost. Romania’s current account balance of payments registered a deficit of EUR 9.92 billion in the first 11 months of last year, up 21 percent compared to January-November 2018, while the fiscal deficit was estimated at 4.3 percent of GDP for the entire year, the highest level in the EU and significantly above the 3 percent-ceiling imposed by the European bloc’s treaties.

At the same time, there are few remaining drivers of growth. In the first nine months of 2019, Romania’s GDP rose by 4 percent, but the increase was mainly due to a surge in construction, by 16.4 percent year-on-year, in the information and communications sector (8.9 percent), in entertainment, culture and recreation activities as well as in the repair of households’ goods and other services (8.6 percent).

But industry, a sector that accounts for almost a quarter of the country’s GDP, declined by 1 percent year-on-year in January-September 2019, agriculture dropped by 4.1 percent, while activity in banking and insurance decreased by 0.4 percent. The industrial sector’s underperformance continued in the last quarter of 2019.

“All three major industrial groups (manufacturing, energy and mining) were deeply in the red. At the same time, local manufacturing was among the weakest in the EU in November (-4.6 percent y/y). This development had been visible since the spring of 2019 and suggests a series of price and non-price competitiveness issues for local manufacturing, besides the impact of the global trade conflict and changes in the car industry,” BCR’s analyst Eugen Sinca wrote in a research note. At the same time, Romania’s exports resumed the widening trend in their negative contribution to economic growth amid a more pronounced reacceleration in the growth of imports relative to that of exports of goods and services.

“The trends were viewed as particularly worrisome by some Board members, inter alia in the context in which the weakening of exports had also coupled with a faster decline in industrial production, mainly on the back of the automotive segment, carrying the potential to increase the negative contribution of that sector to GDP dynamics, on the supply side,” Romania’s central bank noted. Fiscal woes coupled with weak external demand and the workforce crisis are factors that limit the growth potential in 2020 and the following years and put pressure on the government and businesses alike to find new development strategies, experts say.

Targets for the next decade

In this environment of lower fiscal resources, the government needs to address some urgent goals. Unlike Hungary or Poland, Romania has failed to improve its road and rail infrastructure, and its rural areas have remained poorer than those of its regional peers. These goals could be seen as crucial in making Romania more attractive for investors – and even more importantly, for its own people.

Official data suggest that Romanians are still leaving their country at a worrying rate and many local experts are trying to find the real drivers behind this trend. Some entrepreneurs and politicians think they have the answer: beyond earnings, people leave mainly because they’re seeking a better quality of life for themselves and their children.

Many experts suggest that investment in infrastructure – and this includes a large spectrum of targets, from roads and railroads to urban or rural infrastructure – is key to improving quality of life. In many developing countries, this has also become a political issue, as politicians understand that promising a good quality of life could be the winning ticket in the electoral lottery.

For the first time in decades, Romania now seems to be mature enough to address this issue of rising importance among its inhabitants. It is no wonder that quality of life has become so important in Romania, as millions of people have already emigrated to wealthier countries and have enjoyed the living standards offered by those places. Meanwhile, the other millions of Romanians who chose to remain in their country have had the opportunity to travel and compare their living standards with those in different countries and are now pressuring the authorities to improve the situation at home.

In terms of quality of life, Romania’s cities still have plenty of improvements to make if they want to be compared with cities in the western world. In Mercer’s 2019 edition of the “Quality of living city ranking” survey, Bucharest moved down two places, coming in at 109 out of 231 ranked cities. Despite its huge financial resources and high earnings, Bucharest is affected by poor public management, incompetence, and stunning corruption.

But other cities in Romania have started to really improve. In some cities in Transylvania, where urban life emerged earlier and was historically more sophisticated, the quality of life is much higher and the situation is improving every year, helped by EU funds. Cities like Cluj, Sibiu, Oradea or Timisoara are attracting people and developing, while cities in other parts of the country still offer low quality of life and provide little hope to their residents – and they are losing people at a rapid pace.

Improving quality of life is crucial in shaping Romania’s future, and this could be seen as one of the country’s main priorities in the next decade.