Romania, with year on year GDP growth at 8.8%, is currently the fastest growing economy in the EU. It is beginning to resemble the period before the financial crisis of 2008, where Romania was known as a “tiger” economy due to the growth rates it produced regularly, as high as 8 or 9%. Nevertheless, despite this exceptional performance, there are still some fundamental structural issues which have the potential to undermine the future of the Romanian economy.
What’s Driving the Growth?
The IT services sector, as well as manufacturing in areas such as electronics and car production, are where Romania exhibits a comparative advantage over other countries in the region. Foreign direct investment is also a main driver behind this, with net inflows at around 3% of yearly GDP in 2016.
In fact, renowned multinational Phillip Morris began the construction of a new factory worth half a billion euros just outside Bucharest. Nevertheless, there has also been a consumption boom helped by the growing middle class, as well as the low-interest rate environment. With consumption expenditure forming around 70% of aggregate demand, this has an even more significant impact on GDP than countries such as the UK.
There have been concerns that this consumption boom may be artificially buoying the economy, however, the interest rate of 1.75% has been relatively higher than many economies during the last couple of years, so the National Bank of Romania still has some room for manoeuvre.
The head of the National Bank of Romania, Mugur Isarescu, nevertheless stated that “the period with very low-interest rates is over, and not only in Romania”. The inflationary pressures of this consumption are clearly being seen, due to the increase in inflation to 3.2% in December.
Concerns about salary rises in the public sector may account for the fact that most of this rise has been in the last few months. However, the central bank is yet to make a move on interest rates, therefore the demand side conditions still remain favourable for expansion.
Another serious weakness is infrastructure, especially in terms of transport. Romania only has around 750km of motorways currently functioning, which is another area where it is lagging among the last in Europe.
The transport minister promised in February 2017 that there would be 90km added over the year, but only around 15 materialised. Embezzlement of EU funds and wasted money on “feasibility studies” have been some of the major factors hindering the development of Romanian roads.
This area of the economy is the epitome of how political negligence and corruption can lead to such astounding underperformance. Nevertheless, even though the plan of action for Romania to correct this area of weakness is quite straightforward, there are other issues that will be much more complex to tackle.
Like quite a few Eastern European countries, Romania is experiencing a declining population, but for Romania this issue is compounded by both significant emigration in conjunction with a low birth rate. In fact, the current population of 19.7m has almost reached the level of 1966.
This emigration is one of the biggest obstacles for Romanian GDP growth in the long term, with the “brain drain” already becoming a serious problem in areas such as healthcare, where around a third of hospital positions are unfilled. However, it is not just this sector, but the whole economy where wages are still a long way behind.
According to data from the Romanian National Institute of Statistics, gross average wages have hardly moved from the 3300 RON (£650) level for the whole of 2017. This is why the benefits of growth must quickly translate into an improvement in living standards otherwise this exodus will continue.
However, not only is the population declining due to emigration, it is also ageing significantly, with the dependency ratio expected to more than double by 2050, from 21.7% to 49.6%. Not only will this put immense fiscal pressure on the government in terms of state pensions, but it also means that Romania will lose some of the competitiveness it has in attracting FDI, as there will be further upward pressure on labour costs, on top of the wage growth from rising national income.
Recent moves by the Romanian government to cut pension contributions for private pension schemes to 3.75% is not a sustainable way of addressing this fiscal pressure, as it will hurt investment and growth by disrupting a system which had reached significant improvements.
Although pushing harder on pro-natalist policies could help, the distributional concerns with this GDP growth are actually underlying both issues. The inadequate level of incomes is not only a major factor behind the emigration but is not helping the birth rate either. An indicator of this is a study from the ONS, from 2014, which shows that the average number of children per female for Romanian mothers in the UK, is 2.93, compared to just 1.25 back home.
Short vs Long-term
There are also other key issues with the labour market in Romania. The labour force participation rate of around 53% is significantly below the EU average of almost 58%. This means that even though Romania has a relatively low unemployment rate at 4.9%, it is still not fully utilising its human capital. Not only that, but Romania has the highest proportion of workers in agriculture out of the whole EU.
Although these factors can be seen as a sign of a lack of development in the Romanian economy, if the government approaches tackling the issue of social mobility more effectively, this could be seen as an advantage. This is because it could provide some spare capacity for Romania to sustain its growth in the long term, by providing some room for a transition to the manufacturing and service sectors in spite of the declining population.
Although all the main indicators point towards a booming economy, there are still some large structural issues, especially concerning the labour market and infrastructure, which will be challenging to tackle for any future governments, as in some of these areas Romania is right at the tail end of the EU.
Despite all the political tensions and corruption problems Romania is facing even today, even if these are eliminated from the equation, there will still need to be extensive reforms and a thorough approach to reverse these longer-term weaknesses. If these issues are not addressed, it will be difficult for Romania to fully reclaim its status as the “tiger” economy of Europe.
2018: A Bullish Year for Greece?
Two things of importance have recently occurred. The yield on Greek bonds has reached a new low (though, just in time to participate in a potential bear market) and the Syriza led government has enacted measures likely to secure the next tranche of euros. With the Greek economy heading towards achieving 2.5% growth YoY in 2018 and hopefully ending its Sisyphean 10-year cycle of bailouts this summer, the economy is starting to look ripe for foreign investment.
As Q4 2017 approached, things were starting to look up. Either because, as some have thought, after almost 10 years of crisis we’ve reached Greece-fatigue with comparatively lesser news coverage or because, as some notable commentators (such as Deutsche CEO John Cryan or American ambassador to Greece Geoffrey Pyatt) have argued, conditions are genuinely ameliorating.
With return linked to risk, the lowering of the Greek bond yield (which has fallen from more than 7% at the start of the year to 3.92% at the time of writing) is the market’s way of telling us that the outlook is improving.
Equity markets in Greece aren’t doing too shabbily either: Athens Composite Index (ASE: ATH) is up 32.24% at the time of writing, compared to last year. On one hand, it’s tempting to ignore the performance of the index. After all, since the shares have started trading again following the 2015 debacle, most of the companies included in the index – Greek banks, largely – had nowhere to go but up. On the other, reports on Greek industry are surprisingly positive, with the latest IHS PMI report on the region conveying high confidence in the sector and the ‘most marked growth in over nine and a half years’.
The reportage of the past few weeks has been centred on the possibility of Greece exiting its bailout successfully this August, on what it would take to do that and even what success might look like. This past Monday, amongst a furore of protests, the Syriza government moved to enact several fiscal and industrial reforms aimed at hopefully bringing Greece more in line with the criteria of its debtors (more here) in hopes of securing its next tranche of monies.
The vehemence of the protests (with some claiming new quorum rules on strikes are akin to slavery) seems to be inversely correlated with efficacy: Prime minister Tsipras and Finance minister Tsakalotos must surely be looking ahead to Monday the 22nd and up towards mitteleuropa in hope of approval. Whether this is a democratic stance to take is irrelevant, and with the party having a mandate to rule until 2019, they are surely gambling on a return to borrowing at European market levels and financial normalcy without too many stringent conditions. It’s a gamble, yes, but a politically expedient – and perhaps even an astute – one.
Greece offers a tempting arena for investment, but it will take more than access to the European purse to improve things, especially if SMEs and startups – surely an indicator of health in any economy – are to get off the ground. Gone are the days described in Michael Lewis’ Boomerang with its tableau of incognito meetings in hotels with tax collectors who were reprimanded for being too good at their jobs: taxation in Greece has become stringent enough to seriously affect entrepreneurs:
‘For an employee to receive over 2,000 euros net per month, their employer must pay more to the state – in taxes and contributions – than to the worker. When an employee collects 3,000 euros, their final cost to their employer each month is 7,127 euros, of which 4,134 euros goes to the state (58 percent of the total).’ Source
Even maritime activity, traditionally a staple of the Greek economy, is being affected by these strict taxation measures. Despite stirrings amongst Greece’s nascent venture capital community, Syriza-led Greece is hardly shaping up to be entrepreneur friendly and it may well be that we’re looking at an environment better suited to quick-witted, short-term speculators than investors hoping for long-term growth.
More than money is needed for the kind of recovery and environment beloved by investors.
The minotaur is still in the labyrinth, but perhaps 2018 may just turn bullish.
Brexit Phase Two: EU-UK Trade Talks
What unites European political parties across the political spectrum is a demand that while Britain discusses its future with the EU, it adheres to the principle of freedom of movement throughout the phase two transitional period. This is together with all the other rules of EU membership, including compliance with decisions of the European Court of Justice (ECJ).
While Brussels conducts day to day negotiations, it will fall to rotating EU presidents to secure cohesion and solidarity among EU27 member states holding diverse agendas for the conduct of Brexit talks. For the next six months, this leadership task falls to Bulgaria. Romania – the EU’s fastest growing economy (in 2017) – takes on the role in January 2019 at what will be a critical time when Britain (finally) leaves the European Union.
On the 29th March next year, Britain will become a ‘third country’ putting its relationship with the EU on a par with Turkey subject to any refinements on single market entry or a ‘bespoke’ customs union granting limited rights for its financial services sector. Business confidence continues to focus on going concerns that without regulatory alignment with the EU, few benefits will be provided from Brexit. It lobbies for ‘frictionless’ trade, which effectively must keep it in line with single market rules for both goods and services.
Car manufacturers have constantly reminded government ministers of potential damage to supply lines by the imposition of trade barriers. They would assert that decades of foreign investment (FDI) in the UK car industry was made in good faith in the knowledge that Britain, with its flexible and liberalized economy, provided the best entry point for the more lucrative EU market. In fairness, other factors also played a part – not least that UK employment laws were less restrictive than in mainland Europe as a result of the Thatcher government’s reforms in the 1980s.
There is still a question whether Britain leaves next year without a deal. Although this looks unlikely, Michel Barnier’s team at the EU Commission prepares for this scenario – taking repeated threats from the hard Brexit camp at face value. Tracking progress for the shape of an eventual deal is not easy, but clues are already appearing. French President Macron’s visit to London on Thursday 18th January helped to re-invigorate the ‘Entent Cordiale’ which historically focused on European military defence cooperation. A renewed Calais Agreement to maintain a tight border on migration would also help to improve Franco-Anglo relations.
But on a post- Brexit trade agreement Macron stands firm in stating:
“If you want access to the single market – including financial services be – my guest. But you need to contribute to the budget and acknowledge European Jurisdiction. There will be no hypocrisy in this respect otherwise it would not work. It would destroy the single market.”
It is hard to see from this statement that the EU27 will weaken from this stance, or that France can be persuaded of a more pragmatic approach by other EU members.
However, this did not stop PM Theresa May from re-iterating her desire for a deep and special partnership with the EU: “I believe it should cover goods and services.” She went on to say “I think the city of London will continue to be a major global financial centre… That is an advantage not just for the UK, it’s actually good for Europe and good for the global financial system.”
In the coming months, understandably, Britain will seek to pick off different EU states to push forward its vision of future trade relations. It is unlikely this “divide-and-rule” strategy will ultimately succeed, and it may well delay the satisfactory outcome of negotiations within the agreed timeline. It is in the interest of both sides to hammer out a deal for the stability of the EU and UK economies.
May Meets Macron
The UK prime minister agreed to pay £44.5m towards tighter border security at Calais.
Editor’s Remarks: The French president arrived in the UK for the Anglo-French summit amid widespread complaints from the Tory party about just why Britain is paying another £44.5m for tighter security in France. One Tory MP pointed out that this addition brings the total figure the UK has paid to France in recent years up to £170m. France, meanwhile, says that the amount is necessary because the migrants in Calais are trying to get to the UK, who must, therefore, contribute towards their costs. The talks were also consumed by the imminent task of reaching consensus over the UK’s trade deal with the UK after Brexit goes through.
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