Romanian Business Digest.set2006

September 2006

Edited byINTERNATIONAL BUSINESS PROMOTION

General Manager Dumitru IonEditorial Coordinator Mircea Jalb`

Executive Manager M`d`lina AthanasiuProject Manager Diana Dumitra[cuSales Manager Oana GuiuProject Assistant Luiza Iliescu

IT Manager Liviu Munteanu

DTP Manager Nicoleta GrigoriuProduction Manager Carmen Popescu

ACKNOWLEDGEMENTSThe publisher wishes to thank:ABN AMRO RomaniaAlpha Finance RomaniaAutomotive Manufacturers and Importers AssociationBanca Comercial` HVB }iriac & Unicredit RomaniaBanca Comercial` Romn`BrandientBucharest Stock ExchangeCentral Europe Trust CompanyColliers InternationalDeloitteEBRDEFG Eurobank FinanceErnst & YoungGfK RomaniaIBM RomaniaIDC RomaniaING BankIntellinews ISI Emerging MarketsKPMG RomaniaLarive RomaniaLeadership Development SolutionsLeasing and Non Banking Financial Services Association - ALBMagazinul ProgresivNational Bank of RomaniaNational Institute of StatisticsNestor Nestor Diculescu Kingston PetersenPachiu & AssociatesPI PartnersPricewaterhouseCoopers Management ConsultantsRaiffeisen Capital & InvestmentRaiffeisen Investment RomaniaRoland Berger Strategy ConsultantsRSM HemmelrathRomanian Commodities ExchangeSalansThe Economist Intelligence UnitThe Employers Association of the Software and Services IndustryThe Romanian Association for International Road TransportVanguard Investi]ii FinanciareWorld Bank Office Romania

and to all the others involved in this project.

ISBN 973-8006-13-9Printed by PROTIP s.r.l.

Distribution: Romanian Business Digest has a free distribution. Any copy available only free of charge, not for sale.

Copyright 2006

INTERNATIONAL BUSINESS PROMOTION srlComplex ROMEXPO - Pavilion 44Bulevardul M`r`[ti Nr. 65-67, Cod po[tal: 011465, Sector 1, Bucure[ti,

Tel.: +40 21 317.03.90; 317.03.91; 317.03.92; 317.03.95Fax: +40 21 317.03.93, 317.03.94.

E-mail: [email protected]; [email protected]

www.doingbusiness.ro

Note: The publisher cannot, under any circumstances, assumeresponsibility for damages resulting from the use of the informationprovided in this publication. The information contained was providedby sources believed to be dependable. However the publishercannot accept responsibility for its accuracy. No part of thispublication may be reproduced, copied or distributed in any form orby any means, electronic or printed, without the permission of thepublisher or the contributor.

World Bank Office Romania

Romanian Business Digest

Foreword

Dear Reader,

We have the pleasure and the honour to introduce to you the September 2006edition of Romanian Business Digest, edited by IBP Publishing & Conferences.

The high quality information provided by our editorial contributors positions ourdigest as the reference source of information on the Romanian businessenvironment.

Articles, studies and reports published in Romanian Business Digest arecomplemented by Major Companies in Romania, the database featuring thelargest companies active on the local market, a direct result of our in-houseresearch.

The information is available for free both in printed and electronic format and, ifyou wish to learn more about this multimedia information system, we gladlyinvite you to visit our website at www.doingbusiness.ro.

The September 2006 edition of Romanian Business Digest will benefit from aspecial distribution on the occasion of two significant international events:

Eighth Business Roundtable with the Government of Romania, organised byEconomist Conferences in Bucharest on October 30-31, 2006;

Emerging Europe Energy Summit, organised by IBP Publishing &Conferences to be held in Vienna during November 9-10, 2006.

We would like to thank once again all our editorial partners involved in themaking of this edition and we hope that the readers will find interesting anduseful information for their projects and activities.

Romanian Business Digest Editorial Team

Contents

7

General Economic Trends

11 Romania: Fundamental Driversby ING Bank

16 Romania - Economic Overviewby Deloitte

21 Positive Outlook with Focus onDisinflation and EU Accessionby Banca Comercial` HVB }iriac& Unicredit Romania

25 NBR Braces for Larger Deficitsby ABN AMRO Romania

29 Romania Outlook for 2006-07by The Economist IntelligenceUnit

Foreign Investment Climate

37 Foreign Direct Investment inRomaniaby Larive Romania

48 M&A Market in Romania - PastEvolutions & Future Trendsby PricewaterhouseCoopersManagement Consultants

52 Legal Considerations forForeign Investorsby PI Partners

57 EBRD in Romaniaby EBRD

60 Romania and World Bankby World Bank Office Romania

Romanian Business Environment

65 Evolutions and Perspectives inthe Romanian Economyby Banca Comercial` Romn`

72 Financial Reporting in Romaniaby Ernst & Young

79 Taxation in Romaniaby Ernst & Young

93 Latest Developments in theRomanian Tax and FiscalEnvironmentby RSM Hemmelrath

98 The New Customs Code and itsRules Application, starting with19 June 2006by The Romanian Association forInternational Road Transport

103 False Friends in RomanianShare Transactions?by Nestor Nestor DiculescuKingston Petersen

108 Survey of Public PrivatePartnership Arrangementsunder the Romanian Lawby Pachiu & Associates

112 Overview of New Provisions ofRomanian Insolvency Lawby Pachiu & Associates

117 From Hire to Fire: Traps in theLabor Codeby Salans

121 Executive Search andLeadership Development inRomaniaby Leadership DevelopmentSolutions

125 (Re)branding Romania - An overview of the nationbranding context and opportunityby Brandient

Capital Markets132 Sources of Finance in Romania

by Deloitte

139 Romanian Capital MarketsRegulatory Frameworkby Alpha Finance Romania

148 Should More RomanianCompanies be Listed on theStock Exchange?by KPMG Romania

153 BSE First Half 2006 -Performance Reviewby Vanguard Investi]ii Financiare

155 Bucharest Stock ExchangeJanuary - June 2006by Bucharest Stock Exchange

Overview ofEconomic Sectors

161 Romanian Banking Overviewby Roland Berger StrategyConsultants

169 The Bank of the Futureby IBM Romania

177 Overview of Insurance &Banking Marketby Intellinews ISI EmergingMarkets

183 Non Banking Financial Marketin Romania - Leasing Sectorby Leasing and Non BankingFinancial Services Association -ALB

185 Organization and Prospects ofthe Romanian CommoditiesExchangeby Romanian CommoditiesExchange

191 Romanian Power SectorOverview - Power GenerationPrivatization just Startingby Central Europe Trust Company

199 Romanian Oil & Gas SectorOverviewby Raiffeisen Capital &Investment

207 Crude, Refining,Petrochemicals Sector inRomaniaby EFG Eurobank Securities

215 Romanian PharmaceuticalMarket in 2006 by Raiffeisen Investment Romania

221 Romanian Telecom MarketOverviewby Roland Berger StrategyConsultants

229 Information Technology MarketOverviewby IDC Romania

233 The Romanian SoftwareIndustry - Still Booming in 2006by The Employers Association ofthe Software and ServicesIndustry

237 Romanian Hotels IndustryOverviewby Raiffeisen Capital &Investment

242 Romanian Construction andReal Estate Reportby Intellinews ISI EmergingMarkets

249 Retail Market - ShoppingCenters in Bucharest andCountrysideby Colliers International

253 Key Retailers' Plans for theSecond Quarter of 2006by Magazinul Progresiv

258 What have you done in the PastFive Years? - Focus on theRomanian Consumerby GfK Romania

260 The Motor Vehicle in Romaniaby Automotive Manufacturers andImporters Association

268 Automotive PartsManufacturing in Romaniaby Central Europe Trust Company

Statistics274 Statistical Indicators

by National Institute of Statistics

281 Macroeconomic Statisticsby National Bank of Romania

300 Advertisers Index

9General Economic Trends

11

Romania: Fundamental Drivers

by ING Bank

Good weather, lax monetary policy spur growth

Early elections could help economic growth

Eroding sentiment for EM brings yields higher

RON strength dented by NBR

The capital market becoming more attractive

Will foreigners keep paying for the C/A deficit?

RON credit more than replaces FX credit

Inflation to undermine NBR credibility

Budget deficit set to widen

Good weather, lax monetary policy spur growth

After a disappointing 2005, the economy surprised with impressive growth of 6.9% YoY for1Q06. Behind this was strong industrial output growth of 4.8% YoY, pushed by a soaringconstruction sector (up 20.4% YoY) and a continuation of the consumption boom (up 10.2%YoY). Given this breakdown of growth drivers, we suspect much of the growth is the result ofloose monetary policy throughout 2005, along with the fiscal stimulus and good weather in thelast three-quarters. Looking forward, signs of healthy growth are sprouting as GFCF increasedby 11.4% YoY. But all this growth spells trouble for the NBR as it will likely increase inflationarypressures and require more tightening for the 2007-2008 inflation targets to be met.

-1

1

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7

9

11

3Q02 2Q03 1Q04 4Q04 3Q05 2Q06F 1Q07F

(%ch YoY)

0

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8

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16

20

GDP Industrial growth Inflation (rhs)

Activity and inflation Fiscal stance and yields

-4-3-2-1012345

3Q02 2Q03 1Q04 4Q04 3Q05 2Q06F 1Q07F

(% of GDP)

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25.0

Budgetary balance (4Q mov avg) 3M BUBOR (rhs)

(%)

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25

30

3Q02 2Q03 1Q04 4Q04 3Q05 2Q06F 1Q07F

(%ch YoY)

3

4

5

6

7

8

9

10

Unemployment (rhs) Wages (lhs)

(%)

Unemployment and wages

-15

-5

5

15

1Q02 3Q02 1Q03 3Q03 1Q04 3Q04 1Q05 3Q05 1Q06

(% of GDP)

Current account FDI Other financing

Current account and financing

ING Bank

12 Romanian Business Digest 2006

Early elections could help economicgrowth

The European Commission (EC) postponed its finalrecommendation for Romanias EU accession untilSeptember, but with a strong message that 1 January 2007will remain as the default accession date. This might appearto be bad news, but in fact it will force the political class to pulltogether for the next few months it is not a secret that thecurrent governing alliance is held together by a thread.

Looking back, it all started with last years refusal by PrimeMinister T`riceanu to resign, which created a big gapbetween the PD, the presidents party, and the PNL, the PMsparty. Since then it has been almost impossible for anymeaningful reforms to be implemented as everyone in theruling coalition has been more concerned with preserving apositive image in the eyes of the electorate. Therefore,infrastructure investment, fiscal reform, property restitutionand fighting corruption were all put on hold. The first two haveimplications for long-term economic growth while the lattertwo contributed to the ECs decision to postpone itsrecommendation for Romania. But besides postponingreforms, the complacent attitude from the political class hasled to unsatisfactory progress in creating the institutionsneeded to channel funds from the EU to different sectors ofthe Romanian economy. As a result, unless the EU providessome compensating inflows, Romania could even become anet contributor to the EU in 2007 instead of a net beneficiaryof EU funds.

Eroding sentiment for EM bringsyields higher

Although there is genuine interest in RON bonds, so far in2006 the Ministry of Finance has cancelled all its plannedauctions as the budget has performed better than expected.At the earliest, we expect the Ministry of Finance to issuebonds at the end of 3Q06 after a third upward adjustment ofthe targeted 2006 fiscal deficit. Shorter-term yields are likelyto remain high due to international monetary tightening andthe risk reduction attitude towards emerging markets whichtranslates into higher risk premiums.

Longer-term yields should continue the downward movementas a consequence of the positive long-term economic outlookand imminent EU accession, but at a measured pace.

RON strength dented by NBRBoth real and nominal appreciation slowed in 1H06 to 4% and3.4%, respectively, due to higher inflation abroad and

accommodative monetary policy at home. We expect furthernominal appreciation in 2006 due to remittances, the laststage of capital account liberalisation and finally good newsfrom the EC on the countrys accession date. However, we donot expect support from the NBR in the short term. Afterannouncing that the 2006 inflation target (5%1%) will bemissed, the NBR does not seem eager to significantly hikethe key policy rate to ensure the 2007 CPI target will be met.Instead, the NBR seems content with using direct measuresto control RON credit growth, much as it did in 2005 with FXcredit. The reason behind the NBRs attitude lies the fear thataggressive monetary policy will lead to real short-term costsfor the Romanian economy.

Thus the NBR is not willing to risk a short-term slowdown ineconomic growth in order to secure non-inflationarysustainable long-term growth. In our view this shows that theNBR is only independent de jure but not de facto. We stillbelieve further rate hikes are needed to consolidate thedisinflation process, but we do not expect major changes untilthe NBR adjusts its CPI forecasts for 2007 and 2008 andmost importantly until the inflation targets for 2008 and 2009are announced. In the absence of restrictive monetary policy,the biggest risk to the RON remains the ballooning C/Adeficit. The probability of this is amplified by erodinginternational sentiment towards EM, especially those with bigC/A deficits. While there are few foreigners in the tiny FXmarket, the fact that it is very shallow leaves it vulnerable tomoves from foreign investors.

The capital market becoming moreattractive

Given the downward movement of the bonds yield and theappreciation of the RON deemed to happen creates thepremises for further increased attractiveness of theRomanian capital market. The liquidity of the market is goingto benefit in the second half of the year also of the freshlylisted entity, Transelectrica and also the potential increase inliquidity in the largest market capitalised stock, Petrom (giventhe recent announcement of the Government we have hightrust that the 8% stake will be added to the current free float).

The improved sentiment for the medium term outlook,expressed through the increased rating of the two key sectors(oil and banking) in Romania offered by S & P and Fitchtogether with the positive financial reporting at 1H06 aregoing to strengthen the rebound in the capital flows accessingthe Romanian capital market especially in the light of apositive report of EU towards Romanian Accession inJanuary 2007.

2.0

2.5

3.0

3.5

4.0

4.5

12/01 9/02 5/03 1/04 9/04 5/05 2/06 10/06F 6/07F

Exchange rate vs USD Exchange rate vs EUR

Exchange rates

6.7

6.9

7.1

7.3

7.5

7.7

2Y 3Y 5Y 10Y

Now -3 Months +3 Months

(%)

Yeld curve dynamics

ING Bank

www.doingbusiness.ro 13

Will foreigners keep paying for theC/A deficit?

The C/A deficit remains a weak point for the economy. Theimmediate danger is RON appreciation. In theory, as long asFDI inflow matches more than 50% of the C/A deficit, a RONsell-off should not be expected. But this is certainly not abinding rule. The main question is: how long will foreignersinvest their savings in Romania to support domestic spendingon foreign goods? The odds of this happening at the currentpace are very low in a world where higher yields in developedeconomies and a possible slowdown in global growth in 2007make investments in EM seem riskier.

Furthermore, even the current structure of FDI, with mostinvestment targeting the domestic market, not the exportsector, should raise questions about C/A sustainability as wemove into 2007.

RON credit more than replaces FXcredit

Increased reserves ratios for FX deposits led to a slowdownin FX credit. This was replaced, however, by stronger RONcredit growth. In fact, the new RON credit dynamic has morethan compensated for the FX credit slowdown and led to anacceleration in total private sector credit growth. Encouragedby its success in slowing FX credit, we expect the NBR toconsider higher minimum reserves for RON deposits. In ourview such measures would only have a temporary effect. FXcredit growth has resumed, albeit at a slower pace, afterinstruments to circumvent the MRR were developed. Weexpect similar developments for RON credit, with growth of60% YoY by the end of 2008 in the absence of significantinterest rate hikes from the NBR.

Inflation to undermine NBR credibility

The NBR has already updated its end-2006 CPI target threetimes this year (from 6% to 6.8% now). Oddly enough, eventhough it also forecasts the output gap to remain positive untilthe first part of 2007, its forecasts for end-2007 inflationremain unchanged. At this point, the 2006 target looks tooambitious yet the target for 2007 will likely remain unchanged.However, even though monetary policy works with a two-yearlag, no target has been set for 2008 and it seems the NBR isconducting policy for the short term. We expect the NBR toannounce a 2008 target of 4%, which in our view will be tooambitious given the almost six quarters of accommodativepolicy and another six quarters of positive output gap.

Budget deficit set to widen

Continuous pressure from the IMF led to a declining fiscaldeficit up to 2005 through lower expenditures. Since then,however, the new ruling coalition has maintained the lowbudget deficit, not on the back of lower expenditure, butrather with the scaling back of infrastructure investment. Ofcourse, such an approach is not sustainable in a transitioneconomy and in 2006 we have already seen two upwardsadjustments of the deficit from 0.5% towards 2%. We expectit to widen in the coming years by at least 1% a year due toRomanias contribution to the EU budget, the co-financing offunds from the EU, and the increase in infrastructureinvestments. And revenues will not likely grow as fast giventhere have been no changes to the tax code.

ING Bank{oseaua Kiseleff Nr.11-13, ING Building, Sector 1, Bucure[tiTel.: +40 21 222 1600Fax: +40 21 222 1401

Contact:Florin C]u, Chief Economist - Financial MarketsE-mail: [email protected] B`nic`, Equity AnalystE-mail: [email protected]

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

2001 2002 2003 2004 2005 2006F 2007F 2008F

Forecasts

Fiscal deficit will add to excess demand

0

5

10

15

20

Jan-

03

Mar

-03

May

-03

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3

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Inflation CORE 1 CORE 2

(%)

Core inflation resumes upward trend

0%

20%

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60%

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120%

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RON credit FX credit Private sector

(Growth YoY)

RON credit fuels total credit growth

-5000

5001,0001,5002,0002,5003,0003,500

Mar

-00

Jul-0

0

Nov

-00

Mar

-01

Jul-0

1

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C/A deficit FDI

(EUR mn)

CA deficit financed by FDI, for now

15

Romania Economic Overview

by Deloitte

EU accession Macroeconomic trends

The private sector and privatization; Foreign Direct Investments

Final remarks

EU accession

Following accession negotiations and the signing of the Accession Treaty by Romania in April2005, Romania committed to adopt and implement the following policies in line with the EUmember states in relation to: free movement of goods, persons and capital; competition policy;agriculture; energy; industrial policy; small and medium-sized enterprises; education andtraining; telecommunications and information technologies and environment.

The progress in all these fields is summarised into two major criteria by which Romaniasprogress towards accession to the EU has been monitored by the European Commission,namely: the existence of a functional market economy and the capacity to cope with competitivepressure and market forces within the Union. If in 1997, the EC stated that Romania had madeconsiderable progress in the creation of a market economy, in 2004, the Commission finallyconcluded that Romania complies with the criterion of being a functioning market economy.

Acknowledging the positive changes undergone by the Romanian economy, the EuropeanCouncil confirmed its commitment to welcome Romania as full EU member as of January 2007if the issues mentioned in the commissions May 2006 report will be addressed and solvedwithout delay. At the same time, the Council actively encourages the Member States to completethe ratification of the Accession Treaty on time. Even more, the European Commission hasannounced its intention to release the monitoring report for Romania and Bulgaria in Septemberthis year, one month ahead of schedule.

Romanian integration minister Anca Boagiu promised to present the progress made in key areason July 14th in front of the EU representatives and have on September 7th a further meeting toinform on the final stage of measures taken by the authorities.

After integration in the EU, Romania will benefit from financial support from the Union in the formof structural funds of approximately EUR 2 billion per annum in the first three post-accessionyears.

Macroeconomic trends

The first quarter of 2006 follows on a successful 2005 - the sixth year of uninterrupted economicgrowth, though accompanied by a widening current account deficit and a slowdown ofdisinflation. Although the overall evolution of the economy was positive, a slowdown in growthwas forecasted for 2006, following a tightening of the countrys fiscal and monetary policies afterthe relaxation in 2005.

Surprisingly enough for this forecast, Q1 2006 shows a y/y GDP growth of 6.9%, more thanexpected, and supported by the services sector.

The Romanian currency slowed down its appreciation against both the Euro and the US dollarkeeping a steady range of +/-4% around RON 3.55 to Euro 1. The disinflation process,supported by the appreciation of the local currency, continued in the first quarter of 2006,although at a slower pace, which was mainly due to the increase in administered prices, strongwage growth and booming domestic demand.

Deloitte


GDP, Public Debt

1999 2000 2001 2002 2003 2004 2005Nominal GDP (USD bn) current prices 35.6 36.9 39.7 45.7 57.3 73.2 97

Real GDP growth rate -1.2 2.4 5.7 5.1 5.2 8.4 4.1GDP per capita in PPS compared to 25.6 25.0 26.2 28.2 28.9 31.2 32.5EU-25 average1

Weight of gross value added in GDP (%):- industry: 27.1 27.6 27.7 28.4 28.4 30 28- agriculture: 13.4 11.4 13.3 11.3 11.7 11.6 8.3- construction: 4.9 4.8 5.3 5.6 5.7 5 5.5- services: 45.1 46.6 44.5 45.1 44.6 43.3 45.3General governmental2

debt as % of GDP 24.2 22.7 23.2 23.3 21.3 18.5 23

1) EU-25 = 100. 2) The general government sector comprises the sub-sectors of centralgovernment, state government, local government and social security funds.Sources: Eurostat, the National Bank of Romania, the National Institute ofStatistics, www.securities.com, no additional data available for Q1 2006

During the last 2 years, Romania had a real GDP growth of8.4% in 2004, that eased to 5.2% in 2005 and bounced backto 6.9% y/y in Q1 2006.

As in previous years, the continued GDP growth in 2005 andin the first quarter 2006 was the result of increased domesticdemand, fuelled by the boom of consumer credits with a realgrowth of up to 42% y/y in Q1 2006, a surge in finalconsumption up to 10.2% y/y but also improved exportperformance, determined by an increase in industrial output.

The industrial production index increased 4.5% y/y as of endof Q1, matched by a surge in exports of 17% y/y, close to2005s average of 18% y/y.

Slow but steady progress was recorded in relation to percapita income levels, as GDP per capita in Romania isestimated to stand at approximately 34.7% of the EUaverage, a level that is slightly higher than in previous years,but still rather low if compared to the ten latest-joiners of theUnion, where it ranges from 47% in Latvia to 83.4% in Cyprusas of 2005.

GDP per capita in PPS in Romania, Bulgaria, Hungary, the Czech Republic and France, as compared to the EU-25 average

Source: Eurostat, no additional data available for Q1 2006

Services continue to have the greatest contribution to GDP,but their weight reaches to approximately 41% in Q1 2006,the same as last year, as compared to levels in the region of

60% in Hungary or the Czech Republic, or even 73% inFrance or the United Kingdom.

Industry ranks second with 4.8% y/y in Q1. Due to seasonalinfluences agriculture shrinks in Q1 of 2006 to 5.3% y/y of theGDP.

Total governmental debt stands at one of the lowest levels inEurope approximately 23% of the GDP, as of end-2005,less than half of the EU-25 average of 60% (of GDP). Withforeign public debt moderately increasing with 5% y/y in thefirst quarter of 2006 to reach 46% of total debt, Romania isstill in a good position to attract further financing from abroad,considering also that the favourable economic evolution hasattracted successive upgrades of the countrys rating, leadingto diminishing risk premiums on Romanian sovereign debt.

Inflation, Foreign Exchange 1999-2006

1999 2000 2001 2002 2003 2004 2005 2006*

Inflation rate (Dec. on Dec.)54.8% 40.7% 30.3% 17.8% 14.1% 9.3% 8.6% 6.8%

Inflation rate (annual average)45.8% 45.7% 34.5% 22.5% 15.3% 11.9% 9% 8.0%

Year-end exchange rate (RON per USD)1.8255 2.5926 3.1597 3.3500 3.2595 2.9067 3.1078 2.8300

Year-end exchange rate (ROL per EUR)1.8331 2.4118 2.7881 3.4919 4.1117 3.9663 3.6771 3.8700

*forecasted valuesSource: The National Bank of Romania, www.securities.com, EconomistIntelligence Unit

Inflationary pressure persists due to international energyprice hikes, as well as further increasing wages without acorrelation to improvements in productivity. The increase inconsumer prices was less than anticipated, due to the factthat the newly introduced tax on vice, similar to an excise onalcoholic beverages and tobacco, was not fully passed to theend-user prices by producers and retailers.

Inflation moved up to 7.3% y/y in Q1 2006 in line with centralbanks expectations.

Foreign Trade

Foreign trade registered a continuously increasing trend overthe past 15 years but the true breakthrough was recorded inthe year 2000 when the Romanian government, in an attemptto limit current account deficit decided to lower tax on profitsrelated to the export activities to only 5%.

Foreign trade evolution in Romania during the period1997-2005

Source: National Bank of Romania

After 2 years of consolidated positive trend and followingagreements with IMF and EU, the government announced

05

1015202530354045

1997 1998 1999 2000 2001 2002 2003 2004 2005export import

USD billion61.8

31.2

28.928.225.6 25.0 26.2

32.5

64.9 63.8 64.966.4 67.9 70.4 72.7

51.9 53.055.9 58.2 59.4 60.2

113.9 113.8 114.1 112.3 111.5 109.4 109.2

30.4

29.826.1 26.6 28.0 28.331.9

0

20

40

60

80

100

120

1999 2000 2001 2002 2003 2004 2005

Romania Czech Rep. Hungary

France Bulgaria EU-25=100

Deloitte


plans to align tax on profit related to export activities to thegeneral taxation system over a 3 year period. Consequently,in 2002 the tax rose to 6%, in 2003 it reached 12.5% andfinally starting 2004, tax on profits resulting from exportactivities is no longer differentiated.

Although the level of both imports and exports has been on asteady upward trend, the gap between them has beenwidening in recent years for most product categories. Thebooming consumer credit starting 2003 has sharplyincreased aggregate demand, but internal production couldnot satisfy such demand in terms of quantity or quality, soconsumers started to increasingly rely on imported products.

GDP levels 1999-2005

1999 2000 2001 2002 2003 2004 2005Current account deficit (% of GDP)

3.5% 3.8% 5.5% 3.7% 6.7% 8.2% 8.1%

Source: National Bank of Romania

Accordingly, the main challenge for Romania for 2006, inorder to achieve sustainable growth, will be to reduce thecurrent account deficit, which has reached the alarming levelof 8.2% of GDP in 2004 and immediately calls for committedactions to curb aggregate demand and for structuralmeasures to stimulate exports.

In the first quarter of 2006, exports increased by a remarkable17% in all sectors. The forecast for average growth this yearis at an optimistic 15-20%, especially considering that thegrowth may no longer be fuelled by a constant growth incrude oil price and that the steel prices have also ceased tohave massive positive impact as seen in the past years.

Imports increased in Q1 with 28% y/y, slowing down in Aprilto a still high 14%. Especially the imports of crude oil andnatural gas showed a growth of 35% in Q1, accelerating evenmore in the period January to April to 41% y/y, showing thatRomania still remains a net importer of energy resources.

The foreign trade gap widened in the period January to April56% y/y to EUR 2.5 billion. (Source: Intellinews)

Employment and wages

The official unemployment rate levels in Romania weremoderate if compared with those of peer countries in CentralEurope. For instance, according to the EU Statistics Office(Eurostat), in 2004 the Czech Republic had 8.3%unemployment, Bulgaria 12%, Slovakia 10% and Poland18.9%. Still, Romania with 6.2% has a higher rate thanSlovenia (6%) and Hungary (5.9%).

Unemployment levels in Romania during the period 1999-2005

1999 2000 2001 2002 2003 2004 2005

Unemployment rate 11.8% 10.5% 8.6% 8.4% 7.6% 6.7% 5.9%Source: The National Institute of Statistics, National Bank of Romania

In the time period January to March 2006 the number ofemployees increased by a 1.6%, continuing this trend also inApril with an increase of 1%. The number of workplaces inindustry shrunk by more than 4% but with only one increasein the food industry of 6.3%. The retail sector employed 11%more workers in the same period, followed by the financialindustry (banking and insurance).

The average net monthly wage in Romania stood below EUR100 for more than a decade after 1990. The Governmentsreal commitment towards privatization and restructuring ofthe state-owned sector after the year 2000, as well as theforeign investment inflows brought the return to economicgrowth and generated steady increase in income over the lastfive years. The average gross/net monthly wage history inRomania as reported by National Institute for Statistics isshown in the graph below.

The evolution of gross / net monthly salary in Romania during the period 1999-2005

Source: Economist Intelligence Unit, www.securities.com

In fact, the low wages have represented one of the mainincentives for investors over the past 15 years, although theemployment taxation system has been excessive until 2005.Payroll taxes were increased in the late 1990s in the hope ofraising revenues to the state budget. In reality, theseincreases shrank the collection base as a result of theexpansion of informal activities and the widespread practiceof under-declaring wage payments.

The introduction of a 16% tax rate for all salary income levelsas of January 2005 was aimed at bringing part of the greyeconomy into the official economy. However, social securitytaxes are still excessive, despite a series of reductions inrecent years.

In Q1 2006, the average net wage growth of 5.7% y/y is wellabove the expected growth in productivity. The number ofemployees also increased by 1.6% in the same period. Thegain in industry-wide productivity reached a satisfactory 7.5%y/y in Q1 2006.

The private sector and privatization; Foreign Direct Investments

Although with the acquisition of BCR (Banca Comercial`Romn`) in late 2005 by Erste Bank and takeover of oilcompany Petrom by OMV Group in 2004, the RomanianState apparently concluded the series of large-scaleprivatization procedures, there are still a number of otherlarge state-owned companies that are planned to betransferred to private investors in 2006 and in the years tocome.

After some hesitations at the beginning of the year, theRomanian State started the sale procedures for the nationalsavings and loans bank, CEC, and announced the biddingschedule with binding bids expected by July 17th. Under therevised privatization bill, 69.9% of CEC shares will be soldand the preferred buyer is expected to be announced by midSeptember.

The privatization processes of the National Company forFreight Railway Transport CFR Marf`, the Romanian

120144

165

174 180 214

263

95 109117

124 130 154

200

0

50

100

150

200

250

300

1999 2000 2001 2002 2003 2004 Jan-Nov '05

EUR

Gross Net

Deloitte


Post Corporation and radio communications companyRadiocomunica]ii are also gaining momentum.

The privatization of the three remaining electricity distributioncompanies - Electrica Muntenia Nord, Electrica TransilvaniaSud and Electrica Transilvania Nord is also well on track, theprivatization strategy currently being drafted by the sell sideadvisor.

Following Enels successful bid for Electrica Muntenia Sud fora total amount of EUR 820 million for the acquisition of 50%of shares plus subsequent capital increase up to 67.5%,EUR 395 million are expected to flow to state owned parentcompany Electrica.

Several large thermal power plants, namely the energycomplexes of Turceni, Rovinari and Craiova, are alsoexpected to bring significant amounts to the state budget ifthe privatization strategies will be approved by Government.The draft privatization strategy for Rovinari has been sent tothe government for approval by OPSPI and the privatizationadvisor.

At the same time, the Initial Public Offering of shares ofelectricity transmission grid operator Transelectrica has beena real success, the IPO of 10% of the companys sharesbeing over six times oversubscribed and bringingEUR 35 million to the company. Building up on this success,minister of economy Codru] Sere[ re-iterated the decision tofloat the national gas transportation operator Transgaz in thenext 1 to 2 years.

From the portfolio of AVAS tractor producer Tractorul Bra[ovstops operations due to unpaid utilities after failedprivatization attempts. Off-road vehicle producer Aro is alsothe subject of a failed privatization attempt and is forced, bythe Court to admit bankruptcy.

Foreign Direct Investments (FDI)

The outlook for 2006 and the following years is positive, notonly from the point of view of volume of contribution to theshare capital of companies in Romania, but also from thepoint of view of value added by the sectors preferred byinvestors. As Romania is expected to continue its economicgrowth, with indicators such as GDP growth rate, GDP percapita or average wages on a steady upward trend, thecountry will be providing a stable and safe investmentenvironment and investors are expected to shift from lowvalue added sectors (lohn, textiles etc.) to more specialized,technology-intensive fields with high value added. The grossinflow of FDI as reported by the foreign investment agencyARIS is estimated at EUR 6.2 billion this year up fromEUR 5 billion last year and excluding bank privatizationproceeds expected from BCR and CEC. Erste Bank isexpected to pay EUR 3.75 billion for BCR.

Comparison between Romania and other countries in CEE

If until 1996 the performances in the privatization processwere somewhat similar across Central and Eastern Europe,the economic recession in Romania during 1997 2000 hasseverely affected this process, creating a considerable gap interms of number of privatization deals and revenues fromsuch deals between Romania and its neighbours. As after2000, economic growth was resumed and a set of reformswere adopted. For 2004, statistics show a diminishingdifference between Romania and countries like the CzechRepublic, Hungary, Poland or Bulgaria. Given the countrysimminent accession to the EU, its performances should beanalysed not only as compared to previous years, but also ascompared to present or soon-to-be EU member states andthe EU average.

2004 represented a peak for Romania in terms of FDI, whichwas double the absolute size of foreign investments attractedby its neighbour, Bulgaria (Romania EUR 4.1 billion vs.Bulgaria EUR 1.8 billion). However, in relative terms,Bulgaria was among the best performing in CEE, with netFDI/GDP rising to 9.3% in 2004 and 7.6% in 2005, ascompared to Romanias 7% in 2004 and 4.9% in 2005. At thesame time, net FDI per capita reached EUR 206 in Bulgariain 2005, whereas in Romania this indicator was EUR 162 forthe same year. This comparative analysis shows thatRomania may currently not be exploiting its full potential asthe largest market in South-East Europe and that, pending oncontinued efforts and commitment, the recent favourableevolution can be expected to continue and improve.

Final remarks

In November 2004, following the positive economicperformance of 2004, Fitch assigned investment graderating to Romania3. In September 2005, Standard & Poorsalso revised Romanias rating and raised it to investmentgrade3. At the same time, S&P warns that Romania may beexposed to certain fiscal risks and over-heating of theeconomy, pointing out that the rating for Romania andBulgaria is quite dependent on fiscal and monetary policiesand of entry to eurozone. Moodys rating agency placesRomania sovereign debt at Ba1/positive rating with review forpossible upgrade, bringing the country close to investmentgrade. The decision was fundamented by the governmentsprogress in terms of indebtedness and restructuring, with aconcern expressed over the current account deficit and thelocal currencys strengthening. The review will assess thesustainability of recent improvements, the agency beingoptimistic on the planned 2007 accession to EU to strengthenthese. (Source: S&P, Moodys, World Bank, Intellinews)

The World Bank has endorsed the Country PartnershipStrategy (CPS) earmarking USD 450-550 million annualfinancing for Romania over 2007-2009.

Deloitte{oseaua Nicolae Titulescu Nr. 4-8, America House, Etaj 3Sector 1, Bucure[tiTel.: + 40 21 222 1661Fax: + 40 21 222 1660www.deloitte.ro

Contact: Ilinca von Derenthall, ManagerE-mail: [email protected] - BBB with a stable outlook.

21

Positive Outlook withFocus on Disinflation and

EU Accessionby Banca Comercial` HVB }iriac & UniCredit Romania

Outlook Economic growth Inflation and monetary policy

External balance and FDIs Fiscal policy

OutlookThe economic outlook is generally positive with sound economic growth, gradual disinflation andgood prospects deriving from the forthcoming EU accession. Consumption remains the maindriver behind the economic growth while investments are rapidly accelerating.

The disinflation process continued but is expected to lose pace as both demand and supply sidepressures will adversely impact in the next interval. Bringing inflation on a path consistent withthis year NBR target is conditional on even more restrictive monetary conditions. Further policyrate hikes are still likely as more as the recent upward revision of the deficit target translates intoadditional demand side pressures.

After the modest performance registered last year, the industry is on recovery, stirring up thedemand for investment - oriented imports. Despite growing exports, the current account deficitis widening but remains sustainable in view of the historically high FDIs expected for this year.

2003 2004 2005 2006fReal GDP yoy 5.2% 8.4% 4.1% 5.5%Inflation (CPI) yoy, December 14.1% 9.3% 8.6% 7.0%Unemployment rate (%) 7.6% 6.7% 5.8% 6.0%Exchange rate / EUR, avg 3.76 4.05 3.62 3.59Intervention rate (December) 21.3 17.0 7.5 9.5Current Account / GDP (%) -5.8 -8.4 -8.7 -9.5FDI / GDP (%) 3.7 8.5 6.6 8.3Consolidated Gov. Balance / GDP (%) -2.2 -1.1 -0.8 -2.0Public Debt/GDP (%) (ESA95) 25.9 23.1 19.8 18.9Total External Debt/GDP (%) 30.1 30.1 31.0 31.1

Economic growthThe preliminary figures released by the Statistical Office indicate a rebound in the economicgrowth which advanced to 6.9% in Q1, beyond the market expectations. Following the past-years trend, the economic growth remained mainly consumption driven with private consumptionup to a real 11% yoy. The investment component also expanded by a significant 11% yoy butcontributed only by some 1.8% to Q1 growth, due to limited 16% share in GDP. At the sametime, the growing exports were accompanied by an even higher demand for imported goods,thus resulting in a still significant negative contribution of the net external demand.

On the aggregate supply side, the Q1 GDP was driven by sound growth in services, industryrecovery and booming constructions while agriculture continued to provide a negativecontribution.

The main macro indicators suggest that solid economic growth continued in Q2. For theremaining part of the year we expect good prospects to prevail, with GDP growth for this year tobe additionally helped by the lower base effect, following the modest growth registered in thesecond part of last year. Consumption, both private and public, will remain the engine of growth.However, we expect a slowdown in private consumption growth following the enforcement ofmore restrictive monetary conditions and tighter control as regards the wage policy. Investmentsgrowth is expected to peak to 15%, in view of the industry restructuring and the start up of large

Banca Comercial` HVB }iriac & UniCredit Romania


infrastructure investments projects. The negative net externaldemand will continue to widen, based on robust demand forimported good (mainly industry equipment) despite exportsrecovery. Overall, this year economic growth is expected toreach a sound 5.5% with still active risks coming fromunstable climate conditions.

Inflation and monetary policyThe disinflation process advanced in the first half of 2006,despite some temporary departures from the downward pathdetermined by further adjustments in administrative prices(mainly gas and energy), the newly introduced vice tax andalso some negative impact on the food prices side in the firstpart of the year. The exchange rate appreciation together withNBR control over demand side pressure through enhanceddraining of excess liquidity constituted a real stimulus tobringing down CPI inflation to 7.1% yoy in end-June from8.6% yoy in 2005.

For the second half, we do not expect further visible progressas regards the disinflation process since both demand andsupply side pressures are going to adversely impact CPI. Theexogenous supply side pressures are lower than previouslyexpected but will remain important also this year. Furtherupward adjustments in the administrative prices of energyand/or excise duties are expected for July and then forend-autumn. The inflationary potential of the new upwardrevision of the fiscal deficit target to 2.5% of GDP will add tothe existent demand-side pressures, expected to prevail inthe next interval.

At the monetary policy level, the recent June decision tooperate a further strengthening of the monetary policyconditions is expected to have only a limited impact. The hikeof 25bps in the monetary policy rate will rather support thelocal currency than to be effective as regards tempering downthe demand for banking loans. The increase to 20% (by 4ppsup) in the reserve requirements ratio for RON liabilities willhave a more direct impact in depressing the demand forloans, as the reserve requirements ratio has provedtraditionally a more effective instrument. However, bringinginflation on a path consistent with this year 5% target requiresfurther tightening of the monetary policy conditions. Anincrease in the policy rate is still likely and could support acontrolled appreciation of the exchange rate and further thedisinflation process through imports price channel. Such amove is favored as the repeated increases operated this yearin FED and ECB rates reduce the risks of an unsustainableappreciation of RON.

External balance and FDIsThe current account deficit continued to widen in the first partof the year as the demand for imports remained robust andcontinued to outpace the growing exports. Imports expandedby 26% by end-May, mainly based on the increased demand

for industry equipment. Exports growth recovered to 19.8%following the recovery of the domestic industry and of the EUeconomy. The resulting commercial deficit has reachedEUR 3.5 bn (FOB/FOB) during the same period, triggering alikewise current account deficit. The current account gap isexpected to widen even more, to some 9.5% of GDPyear-end, in view of the enlarged budget deficit target and ofthe projected appreciation of RON. Such a large deficit is byno way comfortable but still sustainable in view of theexpected massive FDI inflows. The latest figures areindicative of historical high FDIs this year as EUR 2.3 bn (up130% yoy), were reported only for the first four months. TheFDIs are going to accelerate in the second half and drive thisyear FDIs to a new maximum, estimated to some EUR 7.5 bnwhen considering also the large inflows coming fromprivatizations (mainly BCR and in the energy sector).

Fiscal policyThe fiscal policy pursued this year by the Government wasrather inconclusive, with the deficit target widened two timesin a row while the Treasury stood on surplus throughout H1.The intermediary figures are indicative of higher than plannedrevenues, equaling RON 41 bn in end-May, as improvedbudget collections resulted based on robust consumption andbetter performance of the overall economic activity. On theexpenditure side, the surplus registered by mid-year,estimated to some 1% of GDP proves that the fund-demanding infrastructure projects has not yet been started.

Under these conditions, it was as more surprising as theGovernment decided to increase the deficit target from 0.5%in GDP to 0.9% in April and then to 2.5% in June. Even if thedecision was based on the necessity to allocate more fundsto start the major infrastructure projects, the extraexpenditure will eventually translate in extra consumption, toput additional pressure on inflation. In view of the surplusregistered so far and in the absence of a clear long-termexpenditure strategy, it is difficult to believe the Governmentwill effectively throw some EUR 3 bn more money in theeconomy in H2 only. We rather believe the actual year-enddeficit will stay below the target, most likely around 2%of GDP.

The problem of extra resources needed to support theinvestment projects has temporarily been tackled byincreasing the budget deficit, but the core issue of scarcebudget revenues is still waiting for a long-term solution. Evenif both EU and IMF has repeatedly advocated for increasingeither VAT or corporate tax, the local authorities seem toprefer to keep the current taxes in place, as the recentadjustments to the Fiscal Code (to be enforced starting nextyear) bring no changes as regards the major tax structure.Over medium term, it is expected that the Government startsreconsidering either an increase in VAT or in corporate tax,as extra resources will be needed in order to support theobligations resulting upon the future EU membership.

Banca Comercial` HVB }iriacPia]a Charles de Gaulle Nr. 15, Sector 1, Bucure[tiTel.: +40 21 203 2222Fax: +40 21 230 8485E-mail: [email protected]

Contact:Ioana P`un, Head of Corporate Communications

UniCredit RomaniaStrada Ghe]arilor Nr. 23-25, Sector 1, Bucure[tiTel.: +40 21 200 2000Fax: +40 21 200 2002E-mail: [email protected]

Contact:Ioana Roescu, PR Officer

25

NBR Braces for LargerDeficits

by ABN AMRO Romania

The context Impact of NBR decisions Conclusions

Confronted with increased domestic unbalances and taking advantage of the supportive globalenvironment, the Romanian central bank seems to have finally decided to have a more hawkishmonetary policy.

The context

The slowdown of the disinflation is no longer news. The NBR itself has signaled in its Mayinflation report that the decline of Core 2 inflation (headline minus administered price minusseasonal prices) seems to have come to a halt. Indeed, both the February and March year-on-year inflation was 5.6%, the same level as the end of 2005 one. After a temporary decline in Aprilto 4.8%, Core 2 inflation jumped in June to 5.2%. Given that the dynamics of Core 2 inflation hasnothing to do with administered prices, it reflects actually the gap between domestic demand anddomestic supply.

Indeed, Q1 GDP growth rate came well above market and official expectations. The 6.9%suggests that the Romanian economy is far from slowing down to its sustainable potential outputestimated to be 4.6-4.8%. The big surprise came from the construction sector, which posted ayear-on-year growth of 20%. The industrial sector rose 4.8%, as predicted by the industrialoutput, while services rose 6.8%. The industrial sector and services sector posted growth ratessimilar to those of a year ago, the construction sector being the main responsible for raising the1Q GDP 1 percentage point higher than in 1Q05. As anticipated by the high growth rate of retailsales, household consumption rose 10.9% year-on-year compared with 12.5% one year ago.Gross fixed capital formation was 11.4%, much higher than the 5.2% posted one year ago. Suchfigures suggest that the Romanian economy is far from cooling down in line with NBRs forecastwhich would have expected a sustainable GDP growth already by mid this year.

Headline inflation (CPI) and core inflation (yoy)

Core 1 - CPI minus administered pricesCore 2 - Core 1 minus seasonal food pricesSource: NCS, ABN AMRO

On the other hand, the speculative inflows, so much feared by NBR in the past, seem to be nolonger a threat. After the significant outflows witnessed in May it is unlikely to see a massivereturn of speculative investors on the Romanian local market even assuming additional rate hikes.

4%

6%

8%

10%

12%

14%

16%

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Feb

-04

Mar-04

Apr-04

May-04

Jun-04

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4

Aug

-04

Sep

-04

Oct-04

Nov-04

Dec-04

Jan-05

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-05

Mar-05

Apr-05

May-05

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5

Aug

-05

Sep

-05

Oct-05

Nov-05

Dec-05

Jan-06

Feb

-06

Mar-06

Apr-06

May-06

headline inflation core 1 % (yoy) core 2 % (yoy)

ABN AMRO Romania


After a period during which central banks had loose monetarypolicies aimed at preventing recessions or even deflations inthe respective countries we face a tightening cycle ofmonetary policies. The main central banks, ECB, Fed andeven the Bank of Japan, tighten their monetary policies inorder to contain the domestic inflationary pressures.Moreover, in a number of important emerging economies,such as India, Koreea, South Africa and Turkey, therespective central banks rose their key rates. It is quite likelythat other emerging countries, mainly in Asia, might follow.Such developments are relevant for a number of reasons.The rising rates in developed markets will make the investorappetite for emerging markets to remain low. It is unlikely thata rate hike in Romania will make investors to treat the countryas a case in itself, as long as they look at emerging countriesas an investment class. But even those considering thatinvestors are sophisticated enough to judge countries on acase by case basis should not worry given the general ratemovement in emerging markets and the concerns producedamong investors by the increasing current account deficit ofRomania.

But despite the fact that all the variables were indicatingconsistently that a rate hike was needed, NBR seemed tohave taken only a last moment decision to hike its key rate by25bps, in June, in addition to the largely anticipated rise of theminimum reserve requirement from 16% to 20% for RONliabilities with a tenor of up to 2 years. The trigger might havebeen the governments surprising decision to widen thebudget deficit for the second time this year but this time bymore than doubling it, from 0.9% to 2.5%.

In its June press release NBR mentioned that recent datashows strong domestic demand dynamics driven by anunsustainable expansion of consumption against thebackground of a rapid increase in non-government credit,especially leu-denominated loans. The expected increase ofthe budget deficit will, in the opinion of the central bank,additionally boost domestic demand pressure both on theexternal deficit and on inflation, which requires monetarypolicy tightening.

Indeed, we see the decision to widen the budget deficit asbeing negative for the macroeconomic balances. This marksthe second time during its mandate that the governmentsfiscal policy is pro-cyclical. In 2005, after a GDP growth of8.4%, a flat income tax of 16% was introduced, leading to ageneral boost of consumption in 2005, and to an inflationovershooting. In 2006, after 1Q GDP growth of 6.9% -significantly above the potential and a sign that disinflation isin danger - the government decides to more than double thebudget deficit.

The need to develop the infrastructure is badly neededindeed. But this is not news. It was already known when the2006 budget was constructed, as well as when thegovernment decided that there is no need to boost budgetrevenues by an increase of either the flat income tax or theVAT. Plans to raise the budget deficit suggest as well that theIMF was correct last year when it attempted to persuade thegovernment to increase budget revenues in anticipation of asignificant increase in budget expenses.

Budget deficit revisions

Source: Ministry of Finance, ABN AMRO

The planned widening of the budget deficit made NBRsgovernor Mugur Is`rescu to express his concerns related tothe potential inflationary pressures and mainly to the impacton current account deficit. He said that any larger deficit willcreate a problem, a pressure either on the balance ofpayments or on inflation. However, should the excessspending be directed only for infrastructure projects theimpact will hit especially the balance of payments. Thegovernors concern was related to the efficient use of thesupplementary funds by saying that this is now the biggestchallenge: how efficient are we using the money and howlittle of them are we going to waste.

His appeal to the government to keep to the pledge of using80 percent of additional spending only for investments aimedat integration in EU and education suggest that NBR wasonly marginally involved in the decision to widen the budgetdeficit. He acknowledged that the wider budget deficit wasone of the reasons for the measures taken by NBR, sayingthat what we need now is a shift from consumption, which isunsustainable.

Impact of NBR decisions

The central banks ultimate objective in taking thesemeasures is to contain medium-term inflation, more preciselythe 2007 inflation, inside the 4%+1% band. The monetarypolicy tightening is intended to slow local currency creditexpansion and reduce consumer spending acceleration. Thisis not going to be easy.

NBRs key rate evolution

Source: NCS, ABN AMRO

8.75%8.50%

0%

2%

4%

6%

8%

10%

12%

14%

16%

Jan-05

Feb

-05

Mar-05

Apr-05

May-05

Jun-05

Jul-0

5

Aug

-05

Sep

-05

Oct-05

Nov-05

Dec-05

Jan-06

Feb

-06

Mar-06

Apr-06

May-06

Jun-06

intervention rate (1M depo)

1M interbank rate (mid)

NBR's monetary policy rate

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2001 2002 2003 2004 2005 2006

planned change to 2.5%

planned change to 2%

change to 0.9%

initial

ABN AMRO Romania


To date, retail sales this year have posted growth figuressensibly higher than in any of the previous years, confirmingthat a consumption boom is under way. Given that the maingrowth driver is food products, the NBR does have a problemfaced otherwise often by central banks in emergingeconomies. The small proportion of products funded byconsumer credit in the consumer basket requires significantrate hikes to contain consumption. Therefore, increments ofat least 50bp would be required.

According to our calculations, the 25bp rate hike plus theincrease in MRR, both decided in June, should translate intoa 35bp increase for the cost of credit, assuming that thebanks decide to maintain their profit margins intact. However,the banks strategies seem more oriented towards increasingor defending their market shares, which means that theincreased cost might rather reduce the profit margin thanincrease the loan rate. Hence, in our opinion we might seeonly a very limited rise of the lending rates and, therefore,only a small slowdown in credit growth and consumptionfollowing the central banks actions.

On the fx market for the reasons already mentionedpreviously we dont expect a major impact, offshore investorsbeing likely to continue to stay on both sides with both buyingand selling orders. A 25bp rate hike is not enough to changeinvestors mood overnight.

Conclusions

It is clear that the central bank is confronted with signs of aweakening disinflation, while the economy again shows signsof overheating. The international context remains favourablefor monetary policy tightening, as interest rate hikes are likelyto continue at the international level.

Further rate hikes should not to be ruled out, if marketconditions would warrant such measures. The creditexpansion, wider budget deficit, GDP growth, EM bearishsentiment and EUR-RON dynamics are all in favour of thecentral banks tighter monetary policy. However as in the pastthe central bank might prefer to wait for the outcomes of theirJune decision before deciding to move further.

ABN AMRO RomaniaBulevardul Expozi]iei Nr. 2, WTCB-E, Etaj 2Sector 1, Bucure[tiTel.: +40 21 202 0400Fax: +40 21 224 2736

Contact:Radu Cr`ciun, Head of ResearchTel.: +40 21 202 0435E-mail: [email protected]

29

RomaniaOutlook for 2006-07

by The Economist Intelligence Unit

Political outlook Economic policy outlook

Economic forecast

Political outlook

Domestic politics

Relations between the two senior parties in the ruling coalition, the centre-right National LiberalParty (NLP) and the centre-left Democratic Party (DP), have reached breaking point followingthe latest dispute between the prime minister, C`lin Popescu T`riceanu (NLP), and thepresident, Traian B`sescu (formerly DP). Relations with the two junior coalition partners, theHungarian Democratic Union in Romania (HDUR) and the Conservative Party (CP), are alsostrained. There is a risk that the differences between the NLP and the DP could become sointractable that the two senior government parties can no longer work together, jeopardisingcrucial EU accession-related reforms. It seems only a matter of time before Mr. B`sescuengineers the removal of Mr. T`riceanu or the holding of pre-term elections. The only thing thatseems to be holding the coalition together and preventing such a denouement is the forthcomingdecision by the EU on the timing of Romanias membership. A recommendation on that will bemade by the European Commission on September 26th. The Economist Intelligence Unitassumes that major changes will be avoided until after that date.

Assuming that Romania joins the EU in January 2007, we expect an early dissolution of thegovernment and a pre-term election in 2007 (the next scheduled parliamentary election is due in2008), with the ruling parties hoping to capitalise on their achievement in securing accession.The NLP and the DP will almost certainly not stand again as an alliance, but another coalitiongovernment will be the likely outcome. The problem is that relations between the NLP and DPhave been so badly poisoned that it seems almost impossible that they could govern togetheragain in another coalition. On the other hand, neither the NLP nor the DP could govern with theformal support of the discredited Social Democratic Party (SDP), the extremist Greater RomaniaParty (GRP) or the populist New Generation (NGP) without discrediting their own parties. Theoptions for the countrys current governing elite are thus circumscribed. Mr. B`sescu may thusprefer to avoid an election and preserve the alliance by changing the prime minister. However,if Mr. T`riceanu were to resist and galvanise support in his own party, this in itself could causesuch political ructions that an election becomes unavoidable. Whatever happens over the nextsix months or so, the outlook is for more political uncertainty, with damaging implications foreconomic policy management.

International relations

A decision on the timing of Romanias EU accession will be made in late September 2006, afterthe European Commission delayed making a final recommendation in its May 16th report. Thereport highlighted four areas of serious concern for Romania: the lack of fully functioningpayments agencies for EU agricultural aid; shortcomings in the system for animal registrationneeded to pay EU farm subsidies and to maintain proper veterinary standards; a shortage offacilities for collecting and treating animal by-products so as to prevent BSE (otherwise knownas mad-cow disease); and the lack of a computer system in the tax administration that iscompatible with the rest of the EU, preventing collection of value-added tax (VAT) throughout theinternal EU market. Romania also has to make progress in areas such as the fight against

The Economist Intelligence Unit


corruption; the functioning of the judicial system; protection ofintellectual property rights (IPRs); veterinary borderinspection; and human-trafficking. Bulgarias list of areas ofserious concern is longer (it has six), and the issues it mustaddress are more fundamental. The Commission has set adeadline of end-September for the two countries to overcomethese shortcomings. It will issue a report on September 26th

and make a recommendation on whether Romania andBulgaria should be allowed to join the EU in January 2007 orwhether membership should be delayed until January 2008.The European Council will then vote and is expected to followthe Commissions recommendation.

We assume that Romania and Bulgaria will do enough topersuade the Commission to recommend EU accession inJanuary 2007, but there is a risk that their membership couldbe delayed until 2008. The Commission is also likely to applyspecific safeguards to both countries if they fail to makeprogress in problem areas, such as veterinary health andfood safety. This would result in the reinforcement of customscontrols and restrictions on the free movement of foodproducts. There are also likely to be substantial financialpenalties for both countries, for example, if they fail toestablish fully operational payment agencies for EU farmsubsidies. The imposition of safeguards may satisfy those EUmember states facing public opposition to furtherenlargement. However, such conditionality would beunprecedented and could generate a backlash in the newmember states, especially since the free movement of peopleand goods is regarded as the most valuable aspect ofmembership.

Economic policy outlook

Policy trends

For some time our baseline economic forecast had assumedthat the Romanian authorities would act to address externalconcerns and tighten fiscal, monetary and wage policies in2006. However, the governments decision in April to doublethe size of the targeted 2006 budget deficit, from 0.45% to0.9% of GDP, led us to revise our assumptions and baselineforecast. In a second budget revision in July, the governmentdecided to increase the budget deficit target to 2.5% of GDP.The governments budget revisions have provoked criticismfrom the IMF, which had advocated a balanced budget in2006 and small surpluses in subsequent years. TheEuropean Commission has also expressed concern aboutthe current policy mix and urged the authorities to adopt amore responsible fiscal stance.

The Ministry of Finance claims that it can direct the extrabudget spending towards non-inflationary investment, butany fiscal loosening is likely to fuel domestic demand andmake it difficult to reduce the size of the external deficits.Without supportive, cautious fiscal and wage policies it willalso be difficult for the National Bank of Romania (NBR, thecentral bank) to meet its inflation target. However, thegovernment feels that it is under conflicting pressure both toincrease public expenditure to prepare for EU membershipand to restrict the size of the budget deficit to allow for higherprivate-sector spending. Furthermore, it is probablypersuaded that it can tolerate large deficits for a little longer,

given the expectation of significant revenue from privatisationand inflows of foreign direct investment (FDI) in 2006-07. Afiscal policy tightening may therefore be postponed until afterthe election of a new government in 2007-08.

Fiscal policy

The governments decision in late April and again in late Juneto increase the targeted 2006 budget deficit, first from 0.45%of GDP to 0.9% and then from 0.9% of GDP to 2.5%, flies inthe face of advice from the IMF and the EU to adopt a moreprudent fiscal stance. The government has indicated thatthere may well be a further budget revision entailingadditional increases in expenditure in October. The fiscalloosening implied by the 2006 budget revisions is likely toexacerbate macroeconomic imbalances, especially thecurrent-account deficit, and to make the task of containinginflationary pressures more difficult for the central bank. Weforecast a deficit of 2.8% of GDP in 2006 and 3.3% of GDP in2007, reflecting the demands of meeting EU membershipobligations, as well as the likely losses to the budget fromstate financing of a new Property Fund to compensatecitizens.

Uncertainty remains about the direction of fiscal policy in2007, for which year the government is under pressure toraise revenue significantly by increasing tax rates. At 30% ofGDP, Romanias general government revenue ratio isconsiderably below the levels prevailing in the EU. Theintroduction of the flat tax is estimated to have resulted inrevenue losses equivalent to 1% of GDP, at a time whenRomania needs to raise revenue permanently in order tocover its contribution to the EU budget, co-finance EUprojects and increase infrastructure spending. The primeminister, C`lin Popescu T`riceanu, has insisted that there willbe no change in the 19% rate of VAT (which accounts forabout 50% of total tax revenue), or in the 16% flat-rate tax,but the Ministry of Finance has hinted on several occasionsthat both tax rates may be reconsidered (for example, anincrease of 3 percentage points in the VAT rate to 22%, or asmaller increase in both the VAT and flat-tax rates). As yet,however, there is no consensus in the government about howto proceed, and the revised fiscal code does not include anyincrease in the main tax rates for 2007.

Monetary policy

A monetary policy tightening by the central bank aims tocounter the consumption boom of the past two years andpreserve the disinflation trend. The NBR switched to a directinflation-targeting regime in August 2005, setting year-endinflation targets of 7.5% in 2005 and 5% in 2006, within aband of 1 percentage point. However, the NBRscommitment to the new policy was called into question by aloosening of monetary policy in 2005 and by the failure thesame year to meet the inflation target. In response, in the firstquarter of 2006 the NBR raised the monetary policy rate (themaximum level for money market deposit-taking) from 7.5%to 8.5%; it also raised the reference rate (the effectivesterilisation rate at which the central bank drains liquidity fromthe market) to 8.5% in March, from the 7.5% rate in operationfrom November to February. The NBRs vigorous efforts to



sterilise excess liquidity by open-market operations arestarting to have an impact on money supply growth, andincreases in the minimum reserve ratio on creditsdenominated in foreign exchange have led to a pronouncedshift towards local-currency lending. However, theacceleration of credit growth during the subsequent twomonths fuelling the consumption boom and driving up theexternal deficits and the fiscal loosening implied by thegovernments two budget revisions led the central bank totake further steps to tighten monetary policy at the end ofJune. At its meeting of June 27th, the NBR board decided toraise the monetary policy rate again, to 8.75% per year, andincreased the minimum reserve requirement onleu-denominated liabilities with maturities of up to two yearsfrom 16% to 20%. The latter decision was taken in a bid toslow the continued, fast-paced credit growth, especially ofleu-denominated loans. The NBR has hinted that it isprepared to raise interest rates further if necessary, and weexpect the central bank to persist with a cautious monetarypolicy in 2006-07, with interest rates remaining high this yearand declining only slightly in 2007.

Economic forecastInternational assumptions

International assumptions summary(% unless otherwise indicated)

2004 2005 2006 2007Real GDP growthWorld 5.6 5.0 5.0 4.4OECD 3.2 2.7 2.9 2.3Eurozone 12 1.9 1.4 2.0 1.7EU25 2.4 1.7 2.3 2.1Exchange rates100:USD 1.1 1.1 1.1 1.0USD:EUR 1.244 1.245 1.296 1.390SDR:EUR 0.84 0.84 0.86 0.88Financial indicatorsEUR 3-month interbank rate 2.13 2.15 3.06 3.75USD 3-month Libor 1.62 3.56 5.50 5.44Commodity pricesOil (Brent; USD/bn) 38.5 54.7 70.0 66.0Gold (USD/troy oz) 409.5 445.0 639.5 700.0Food, feedstuffs & beverages (% change in USD terms) 8.5 -0.5 4.0 -4.2

Industrial raw materials (% change in USD terms) 21.0 10.3 41.4 1.8

Note: Regional GDP growth rates weighted using purchasing power parityexchange rates.

Global economic growth slowed to 5% in 2005, from 5.6% in2004 (at purchasing power parity PPP exchange rates),and is expected to slow in 2006-07 to an annual average of4.7%. Growth in the EU, Romanias main export market, hasbeen held back by weak domestic demand and high oilprices, and we expect EU growth to average 2.2% in2006-07. The average weighted growth of import demand inRomanias 20 leading export markets is forecast to slow to4.8% in 2006, from 5.1% in 2005, and to pick up to 5% in2007.

Prices for dated Brent Blend crude oil are set to averageUSD 70/barrel in 2006 and USD 66/barrel in 2007, reflectingrobust demand, growing concerns about Irans nuclear

programme and the fact that new oilfields are not coming onstream as quickly had been assumed. Higher oil prices willhave a negative impact on inflation, although thestrengthening of the euro in 2006-07 will dampen the impactof high oil prices on Romania. With concerns about the largeUS current-account deficit again coming to the fore, the UScurrency is forecast to weaken against the euro, fromUSD1.24:EUR1 in 2005 to USD1.28:EUR1 in 2006 and toUSD1.39:EUR1 in 2007.

Economic growth

Gross domestic product by expenditure (Lei bn at constant 2002 prices where series are indicated;otherwise % change year on year)

2004 a 2005 a 2006 b 2007 b

Private consumption 137 150 159 16810.8 9.7 6.1 5.4

Public consumption 10 11 11 124.6 4.5 5.0 5.5

Gross fixed investment 39 44 49 5610.1 13.0 12.0 13.5

Final domestic demand 186c 204 c 219 235

10.3 c 10.1 c 7.3 7.2

Stockbuilding 3c 3 c 3 3

0.3 cd -0.1 cd -0.1 d 0.1 c

Total domestic demand 189 c 207 c 222 23810.4 c 9.8 c 7.2 7.1

Exports of goods & services 68 73 81 9114.1 7.6 10.3 12.4

Imports of goods & services 85 100 115 13117.8 17.2 14.9 13.5

Foreign balance -17 -27 -34 -40-2.8 d -5.5 d -4.2 d -3.0 d

GDP incl statistical discrepancy 173 e 180 e 189 e 199 e8.4 4.1 5.2 5.5

a - Actual. b - Economist Intelligence Unit forecasts. c - Economist IntelligenceUnit estimates. d - Contribution to real GDP growth (as a percentage of realGDP in previous year). e - GDP data reflect redenomination of the leu on July1st 2005.

Real GDP rose by 6.9% year on year in the first quarter of2006, with private consumption growing by 10.9%. Netexports made a negative contribution of 9.9% to growth.Private consumption growth is expected to slow comparedwith 2005, but not as sharply as previously expected (retailsales, which can be taken as a rough proxy for consumptiongrowth, grew by 24% year on year in real terms in the firstquarter of 2006). Investment activity will continue to be themain engine of growth in 2006-07. Fixed investment grew by11.4% year on year in the first quarter and is forecast to growby 12% in 2006 and by 13.5% in 2007, as new andmodernised production facilities come on stream, large publicinvestment projects get under way and inflows of FDIcontinue to rise. We assume that the slowdown inconsumption growth will contribute to a modest decelerationin the pace of import expansion and that the negativecontribution of net exports to real GDP growth will diminish.Agricultural output is expected to rebound, rising by about 4%year on year in 2006, despite flooding early in the year.Industry, which grew by 4.8% year on year on a value-addedbasis in the first quarter, is expected to perform above the



official forecast, growing by about 5% year on year in 2006.We forecast that real GDP growth will accelerate to 5.5% yearon year in 2007, as investment and export growth accelerate.

Inflation

The NBR set year-end inflation targets of 7.5% for 2005 and5% for 2006, within a band of 1 percentage point. Thecentral banks credibility has been dented, however, by thefailure to meet the 2005 target, with inflation reaching 8.6%year on year in December and averaging 9% annually.Inflationary pressures remain strong as a consequence ofrapid growth in real wages and credit, as well as upwardadjustments to energy prices. In the first half of 2006consumer price inflation has remained above the target band,but in line with the central banks forecast trajectory: in Maythe year-on-year inflation rate rose to 7.3% from 6.9% in April.We assume that the central banks monetary policy tighteningand a strong leu will aid disinflation in 2006. However, the2006 target is unlikely to be met because of scheduledincreases in excise taxes and energy prices. We forecastyear-end inflation of 6.8% in 2006 and of 4.8% in 2007.

Exchange rates

Higher interest rates, the liberalisation of the capital accountand a generally positive view of Romanias prospects willstimulate speculative capital inflows in 2006-07. These couldresult in further significant real appreciation, a costlysterilisation of the inflows, or a combination of both. Followingan annual average real effective appreciation of 17.7%against a trade-weighted basket of currencies in 2005, the leuappreciated against the euro by about 5% in real terms in thefirst quarter of 2006. In the second quarter, the leu cameunder depreciation pressure against the euro as a result of ageneral downturn in sentiment towards emerging markets.We do not expect this to persist and forecast a continued,albeit smaller, nominal appreciation against both the USDand the EUR in 2006. In 2007 we expect further nominalappreciation against the USD, but a nominal depreciationagainst the euro. This will result in real appreciation against atrade-weighted basket of currencies in both years. Theexchange rate appears to be competitive at the moment, butthe substantial appreciation of the leu in 2004-06, togetherwith strong wage growth, has begun to damage profitabilityand competitiveness in some sectors, underlining the needfor more structural reform of the economy. Prudent wage

policies and productivity gains will be needed to offset theimpact of currency appreciation.

External sector

Another risk generated by the tightening of monetary policy isthe potentially adverse impact that appreciation of the leucould have on the trade balance, at least in the short term.Strong leu appreciation could erode the externalcompetitiveness of exports, assuming that any increase inproductivity would be insufficient to compensate, and wouldlead to an increase in demand for imports. The merchandisetrade deficit increased by 50% year on year in euro terms inJanuary-May 2006 (fob:fob); imports grew by 26.2% year onyear and exports by 19.8%. We expect a slight increase in thecurrent-account deficit in 2006 compared with 2005, followedby a modest reduction in 2007.

Forecast summary (% unless otherwise indicated)

2004a 2005a 2006b 2007b

Real GDP growth 8.4 4.1 5.2 5.5Industrial production growth 5.3 1.9 5.5 5.0Gross agricultural production growth 22.2 -13.9 4.0 3.0Unemployment rate (year-end) 6.3 5.9 6.1 6.3Consumer price inflation (av; national measure) 11.9 9.0 7.6 5.7

Consumer price inflation (year-end; national measure) 9.3 8.6 6.8 4.8

Consumer price inflation (av; EU harmonised measure) 11.9 9.1 7.7 5.8

Commercial bank lending rate 25.8 19.6 20.8 14.0Consolidated budget balance (% of GDP) -1.1 -0.9

c -2.8 -3.3

Exports of goods fob (USD bn) 23.5 27.7 33.3 40.9Imports of goods fob (USD bn) 30.2 37.3 46.0 56.6Current-account balance (USD bn) -6.4 -8.5 -10.5 -11.5Current-account balance (% of GDP) -8.5 -8.8 -9.0 -8.4External debt (year-end; USD bn) 30.0 c 39.6c 46.8 55.0

Exchange rate Lei:USD (av)d 3.26 2.91 2.80 2.66

Exchange rate Lei:EUR (av)d 4.06 3.63 3.58 3.70

Exchange rate Lei:USD (year-end)d 2.91 3.11 2.67 2.64

Exchange rate Lei:EUR (year-end)d 3.94 3.67 3.65 3.62a - Actual. b - Economist Intelligence Unit forecasts. c - Economist IntelligenceUnit estimates. d - The redenomination of the Romanian leu on July 1st 2005entailed the dropping of four zeroes: one new leu (RON) = 10,000 old lei (ROL).

The Economist Intelligence Unit26 Red Lion Square London WC1R 4HQ United KingdomTel.: +44 (0) 20 7576 8181Fax: +44 (0) 20 7576 8476 www.eiu.com

Contact: Joan Hoey, Senior Analyst, Central & Eastern EuropeE-mail: [email protected]

35

Foreign Investment Climate

World Bank Office Romania

37

Foreign Direct Investmentin Romania

by Larive Romania

Legal framework with impact on direct investment

Evolution of the foreign direct investment in Romania

Short presentations of some Romanian industries

Investment funds

In the last years, Romania became a more appealing target for an increasing number of foreigninvestors due to the priority objective settled for January 2007, the accession to the EuropeanUnion. This will confirm the fact that Romania is irreversibly connected to the values of theEuropean democracy and the principles of a functioning market economy.

Romania signed in Luxemburg, on April 25, 2005, together with Bulgaria and the representativesof the 25 Member States, the Treaty of Accession to the EU. The signing of the Accession Treatywas proceeded by the assent of the European Parliament, which was given on April 13, 2005,with an absolute majority of votes.

A decision on the timing of Romanias EU accession will be made in September 2006, after theEuropean Commission delayed making a final recommendation in its May 16th report. The reporthighlighted four areas of serious concern for Romania: the lack of fully functioning paymentsagencies for EU agricultural aid; shortcomings in the system for animal registration needed topay EU farm subsidies and to maintain proper veterinary standards; a shortage of facilities forcollecting and treating animal by-products so as to prevent BSE (otherwise known as mad-cowdisease); and the lack of a computer system in the tax administration that is compatible with therest of the EU, preventing collection of value added tax throughout the internal market of the EU.Romania also has to make progress in areas such as fight against corruption; the functioning ofthe juridical system; protection of intellectual property rights (IPRs); veterinary border inspection,and human-trafficking. A report is expected to be issued on September 26th with arecommendation on wether Romania and Bulgaria should be allowed to join the EU in January2007 or whether this should be delayed until January 2008.

Romania will benefit from the EU accession, that offers a harmonization of capital marketregulations, taxation, accounting rules. The exporting procedures to the EU members will besimplified in business administration, the exchange risks and conversion charges will beeliminated after the accession and a new extended market of more than 500 million consumerswill be open.

According to estimates of IntelliNews, which corroborates data from regional central banks,Romania ranks second in the SEE region, after Turkey, considering total FDI inflows by the endof 2005.

Evolution of FDI in South East Europe in the period 1996-2005

Source: Central banks, IntelliNews

0

5000

10000

15000

20000

25000

Albania Bosnia and Hertzegovina

Bulgaria Croatia Greece Macedonia Moldova Romania Serbia and Montenegro

Slovenia Turkey

EUR mn

2001-2005 1996-2000

Larive Romania


In 2006, the investor interest in expected to increase, theRomanian Agency for Foreign Investments (ARIS) predictinga new annual record EUR 5.8 to 6.2 billion in FDI. Thefigure is higher that the projected FDI of EUR 4-4.2 billion for2005, up from an initial estimation of EUR 3.2-3.8 billion.ARIS considers that improvements in the businessenvironment, the flat tax of 16% and a positive attitude fromforeign partners helped improving FDI inflows dramatically.

The activity areas most intensely sought by foreign investorsin 2005 were information technology (IT&C), the energyindustry, the pharmaceuticals market and the automotiveindustry.

The evolution of FDI in Romania between 2000-2006

Source: ARIS INVEST The Romanian Agency for Foreign Investment

Legal framework with impact ondirect investment

In order to improve the business climate and to offerincentives for large investment projects, the Parliament hasissued in 2001 the Law No. 332 regarding the promotion ofdirect investment with significant impact on the economy.Investment that qualify has a value higher than USD 1 million(or equivalent), is made in the forms and ways provided bythe law and contributes to the development andmodernization of the Romanian economic infrastructure,determining a positive spin-off effect in economy and creatingnew jobs. Direct investment with significant impact oneconomy are allowed in all economic sectors with theexception of financial, banking, insurance and re-insurance,as well as the sectors regulated by special laws.

The Fiscal Code, enforced starting 2004, maintained andreinforced the investment incentives introduced by this law,such as:

1. Exemption from payment of custom duties for themachinery, installations, equipment, measuring andcontrol devices, automation equipment and softwareproducts purchased from Romania or abroad, necessaryfor achieving the investment

2. Carrying forward the fiscal loss during the following 5years from the taxable profit

3. Other incentives that may be granted by the localauthorities (such as exoneration or reduction of localtaxes, etc)

A significant step forward taken for improving the relationshipwith the investors is the establishment of a governmentalagency in charge with attracting and maintaining the contactwith foreign investors in Romania. This is the RomanianAgency for Foreign Investment (ARIS), which has as mainobjectives to increase significantly the investment volume inRomania, to actively promote investment opportunities and to

offer professional services for foreign investors, all along theinvestment cycle.

In the period October 1, 2001 - December 30, 2005, ARISmanaged, through regional development agencies, a numberof 445 investment projects, each with values exceedingUSD 1 million, these investors benefiting from facilitiesaccording to the Law on direct investment with a significantimpact upon the economy.

Besides the law on direct investment with significant impacton the economy, the other most important legal incentiveoffered to direct investment in Romania is the new single taxreform, introduced by the newly elected liberal government atthe end of 2004. This fiscal revolution brought Romaniaamong the most competitive investment destinations in theregion. The country was known for its high level of incometaxation: 25% for companies and 18% to 40% for individuals.Starting 2005, following a successful model alreadyintroduced by other countries in the region, corporate andindividual incomes are levied with a single tax rate of 16%.This fiscal reform was coupled with a softening of the taxationprinciples on which all fiscal procedures will be based:transparency, simplicity, partnership with taxpayers, andprudence.

Presently, the Romanian single tax rate is competitivecompared to the other countries levels of taxation, anoverview being given below:

Taxation levels applicable in countries in SEE as of end of 2005

Source: Central banks

This measure has yielded very positive results, as FDI grewat an accelerated pace, favored also by the pre-accessioncontext. According to the experience of other countries, thisfiscal reform will increase Romanias competitive advantagein attracting higher FDI, especially in export oriented, laborintensive and high value added industries.

In spite of the advantages of the new single tax system, itsdownside appeared already after six months. In order tocounter the lower taxes collected on corporate and individualincome, the Government was forced to raise quotas for othertaxes, such as: tax on dividends (from 5 to 10% forindividuals, and subsequently to 16%), tax on capital gains(from 1 to 10%, and then 16%). The new fiscal strategy of theGovernment puts emphasis on indirect taxes, as compared todirect taxes (which are aligned at

Romanian Business Digest.set2006

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