Executive summary 1

1. Scene setter: Economic situation and outlook 3

2. Imbalances, risks and adjustments 12

2.1. External rebalancing and competitiveness 13

2.2. Risk to medium-term export capacity 29

2.3. Financial sector, adjustment and indebtedness 44

3. Other structural issues 55

3.1. Taxation and fiscal framework 56

3.2. Labour market, social issues and education 61

3.3. Governance 72

AA. Overview Table 76

AB. Standard Tables 84

LIST OF Tables

1.1. Evolution of long-term ratings 6

1.2. Key economic, financial and social indicators 10

1.3. MIP scoreboard indicators 11

2.2.1. EU Funds absorption rates 28

AB.1. Macroeconomic indicators 77

AB.2. Financial market indicators 78

AB.3. Taxation indicators 78

AB.4. Labour market and social indicators 79

AB.5. Labour market and social indicators (continued) 80

AB.6. Product market performance and policy indicators 81

AB.7. Green growth 82

LIST OF Graphs

1.1. Real GDP growth by demand components 3

1.2. GDP dynamics 3

1.3. Income per capita, PPS 4

1.4. Components of potential growth 4

1.5. Inflation 5

1.6. Unemployment rates 5

1.7. Government deficit and debt (2006-16) 6

1.8. CDS spreads over BUND 7

1.9. Banking assets evolution (2000-13) and composition by ownership 7

1.10. Profit ROA and ROE 7

2.1.1. NIIP in Romania and peer countries 13

2.1.2. Decomposition of rate of change of NIIP 13

2.1.3. NIIP financing 14

2.1.4. Current account balance by components (4qma) 15

2.1.5. Net lending by sector 15

2.1.6. Current-account balance in peer countries 16

2.1.7. Romanian exports and imports 16

2.1.8. Growth in export market shares in the EU 16

2.1.9. Export market share decomposition 17

2.1.10. Current account balance and output gap 17

2.1.11. Cyclical and non-cyclical CAB 17

2.1.12. Evolution of exports by groups of products 18

2.1.13. Evolution of exports for selected destinations 18

2.1.14. Exports to Germany and Italy, by groups of products 18

2.1.15. Balance of primary incomes 19

2.1.16. REER decomposition 19

2.1.17. ULC in tradable and non-tradable sectors 20

2.1.18. Decomposition of ULC 20

2.1.19. REER vs. export prices 21

2.1.20. Labour productivity per hour worked (EU27=100) 21

2.1.21. Labour productivity in Romania 2008-2013 21

2.1.22. Decomposition of aggregate labour productivity growth 22

2.1.23. Productivity gains/losses due to changes in sectoral productivities (within effect) 22

2.1.24. Dynamism and competitiveness of exports (goods) in top-10 destinations, 2012-13 22

2.1.25. Geographical and sectoral composition of nominal USD rate of change of goods exports 23

2.1.26. Revealed comparative advantages (goods) 23

2.1.27. Import content of exports 23

2.1.28. High-tech products as a proportion of exports in peer countries 23

2.1.29. Share of high-tech products in exports 24

2.1.30. GFCF by type 24

2.1.31. Stock of FDI per sector, 2013 25

2.1.32. Stock of FDI in Manufacturing 25

2.1.33. Stock of FDI per country, 2013 25

2.1.34. FDI stocks in tradables vs. non-tradables 25

2.2.1. Quality of public infrastructure 26

2.2.2. Length of motorways, 2012 26

2.2.3. EU funds absorption in Romania and peers 28

2.2.4. EU funds absorption per Operational Programme 28

2.2.5. Ease of doing business 31

2.2.6. Doing business in Romania 31

2.2.7. Importance of SOEs in the Romanian economy 33

2.2.8. Importance of SOEs by sector 34

2.2.9. Equity valuation of SOEs expressed relative to GDP 34

2.2.10. Employment at SOEs as a proportion of total employment 34

2.2.11. Return on equity of SOEs and foreign-owned companies compared to domestic privately-owned companies 35

2.2.12. Staff expenses at SOEs and foreign-owned companies compared to private-owned companies 36

2.2.13. Labour productivity of SOEs and foreign owned companies compared to domestic privately owned companies 36

2.2.14. Total factor productivity of SOEs and foreign owned companies compared to domestic privately owned companies 36

2.2.15. Payments past due date at state-owned enterprises 37

2.2.16. Return on equity in of SOEs in selected sectors in Romania and neighbouring countries 38

2.3.1. Structure of the financial sector (%GDP) 40

2.3.2. Private credit in selected countries (%GDP) 40

2.3.3. Credit developments (2004-13, %GDP) 41

2.3.4. Loans to private sector (EUR mn and %ch) 41

2.3.5. Evolution of the NPL ratio at system level 42

2.3.6. Coverage ratio of NPLs (%; comparison with selected regional peers) 42

2.3.7. Evolution of capital adequacy at system level (%; 2007- Q2 2014) 43

2.3.8. Total exposure of the nine euro area foreign parent banks to Romania (EUR bn, March 2009 - August 2014) 43

2.3.9. Loan-to-deposit ratio (RON, FX, Total) 44

2.3.10. Private sector indebtedness (% GDP) 45

2.3.11. HH loans as % of GDP (2008 and 2013) 46

2.3.12. NFC loans as a % of GDP (2008 and 2013) 46

2.3.13. Households’ monthly debt service 46

2.3.14. Household debt developments 47

2.3.15. Stock of loans granted by purpose and currency 47

2.3.16. Relative house price index and price-to-income ratio 47

2.3.17. Residential investment and building permits 48

2.3.18. Loans for house purchase and consumption, % GDP 48

2.3.19. Decomposition of corporate lending growth rate by firm size 48

2.3.20. Financial soundness indicators for corporates 49

2.3.21. Non-performing loans per sector, August 2014 (% of loans in the sector) 49

3.1.1. Change in the tax wedge following 5 pps. reduction, by earnings level 51

3.1.2. VAT gap in selected Member States, 2012 53

3.2.1. Labour market indicators 56

3.2.2. NEETs and inactive NEETs (% of population aged 15-24) 57

3.2.3. Persons at-risk-of-poverty or social exclusion in Romania 58

3.2.4. Participation in lifelong learning 62

3.3.1. Overall profile of public administration 66

3.3.2. Governance indicators, Romania and EU 66

LIST OF Boxes

1.1. Economic surveillance process 9

LIST OF Maps

No table of contents entries found.

Under successive assistance programmes key macroeconomic imbalances in Romania concerning the current account and fiscal policy have been considerably reduced and financial sector stability has been maintained. The balance of payments financial assistance programmes were successful in restoring macroeconomic stability, re-establishing market access for the sovereign and safeguarding financial stability. After a sharp contraction during the crisis, growth recovered quickly and is back in positive territory since 2011. Growth reached 2.9 % in 2014 and is expected to remain robust. Unemployment remained contained at around 7 % while inflation recently decreased significantly. Fiscal consolidation was frontloaded but spread over various years. The current-account deficit of more than 10 % in 2006-08 was largely corrected to around 1 % of GDP in 2013 on the back of strong exports and only temporarily reduced imports. This correction contributed to improving the (negative) net international investment position to 60 % of GDP. The banking sector weathered the crisis well and capitalisation remains strong.

This Country Report assesses Romania's economy against the background of the Commission's Annual Growth Survey. The Survey recommends three main pillars for the EU's economic and social policy in 2015: investment, structural reforms, and fiscal responsibility. In line with the Investment Plan for Europe, it also explores ways to maximise the impact of public resources and unlock private investment. So far, surveillance of economic policies for Romania has taken place under the programmes. In its 2015 Alert Mechanism Report, the Commission found it necessary to determine whether macroeconomic imbalances exist in Romania. This Country Report thus also assesses Romania in the light of the findings of the 2015 Alert Mechanism Report. To this end the Country Report also provides an in-depth review of Romania.

The main findings of the In-Depth Review contained in this Country Report are:

· While Romania’s net international investment position indicates some remaining risks, key imbalances have been corrected. The still significantly negative net international investment position remains a source of macroeconomic vulnerability. However, export growth points to improved macroeconomic resilience. Formerly unsustainable current-account deficits have been corrected and are expected to remain contained. Labour productivity started to improve only recently, and cost competitiveness is still not ensured. Non-cost competitiveness is still hampered by low investment and innovation and an unfavourable business environment.

· Despite important reforms, deficiencies in the business environment might threaten much needed investment and Romania’s export capacity. Structural funds could significantly contribute to financing important investments, but implementation continues to face major obstacles. Access to finance remains difficult, particularly for small and medium-sized enterprises. Energy and transport infrastructure continues to be a bottleneck to growth. Insufficient quality of education and its mismatch with the labour market, limited public administration capacity and an unstable tax policy constrain investments and exports. Inefficiencies in state-owned enterprises dominating key sectors like energy and transport are a burden on public finances and a drag to the entire economy.

· Private debt has been contained and financial sector stability has been preserved, but external and internal vulnerabilities remain. The Romanian banking sector is well capitalised and liquid, and non-performing loans are on a decreasing trend. Still, deleveraging pressures remain and impaired loans weigh on banks’ profitability. Banks remain vulnerable to adverse developments in the euro area and particularly to home-grown initiatives which may have an adverse impact on the sector that could be mitigated under the balance of payments programme. Private-sector indebtedness remains contained.

The Country Report also analyses macroeconomic and structural issues and the findings are:

· Tax compliance remains limited, while tax policy is rather unstable. Although measures to increase the efficiency of the tax administration are being implemented, value added tax compliance is among the lowest in the EU and undeclared work weighs on budget revenues. Frequent changes to the tax system contribute to instability in the business environment.

· Labour-market dynamics show signs of improvement, but structural issues persist. Poverty and social exclusion continue to affect a large proportion of the population. Unemployment is low and decreasing, but this is mostly due to persistently low activity rates. Access to the labour market by vulnerable groups remains difficult and the quality and access to early childhood education and care, vocational training, apprenticeships, higher education, and lifelong learning are low. The capacity of the National Employment Agency is a constraint. Despite important actions, youth unemployment and inactivity rates remain high. Romania has the highest proportion of the population working in agriculture in the EU, with substantial under-employment in subsistence and semi-subsistence farms. Although declining, a large proportion of the population is severely materially deprived. Effectiveness of social transfers is limited. The Roma population experiences worse employment and social outcomes. Children's rights are often not effectively enforced. Healthcare reforms have been stepped up, but healthcare outcomes, accessibility and efficient use of resources remain an issue, in particular in rural areas.

· Persistent weaknesses in public administration and in the overall business environment weigh on the country’s economy. Important reforms aimed at increasing the quality of public services and the predictability and quality of policies, and at achieving a regulatory environment more favourable to business and citizens have been approved, but concrete measures are not yet fully implemented. Consolidating progress on the efficiency, quality and independence of the judicial system and in the fight against corruption remains a challenge.

Overall, Romania has made limited progress in addressing country-specific recommendations. Implementation of measures envisaged under the balance of payments programme is uneven. Preliminary data puts the 2014 deficit in line with programme objectives; the 2015 budget targets Romania’s medium-term objective of a deficit of 1 % of GDP in structural terms (plus a so-called EU funds adjustor of 0.25 % of GDP); clearance of non-performing loans is progressing; the balance-sheet assessment in the insurance sector is on track; and gas-price liberalisation for non-households comes into effect from 2015. Yet, various reforms have stalled, including privatisations, restructuring of loss-making state-owned enterprises, the adoption of covered bonds legislation, the setting-up of specialised courts for cases involving unfair contract terms, transparent minimum wage setting, equalisation of the pension age of men and women, and improvements in the business environment. In addition, achievements relating to the governance of state-owned enterprises are at risk, and the previously introduced pension reform is threatened by the planned reintroduction of 'special pensions'. There has been limited progress in streamlining energy efficiency policies, cross-border integration of energy networks and physical reverse flows in gas interconnections, and energy price liberalisation for households was delayed. The cut in social security contributions lowered the tax wedge, but it was not targeted at low- and middle-income earners.

The Country Report reveals the following policy challenges stemming from the analysis of macroeconomic imbalances. Risks for maintaining fiscal policy and financial sector stability remain, but can be subdued by implementing in full the agreements reached in the balance of payments programme and by ensuring a smooth transition to post-programme surveillance, including strengthening domestic anchors. The main challenges ahead regard: accelerating the pace of structural reforms to improve competitiveness and expand growth; building-up public research capacities in order to develop new sources of growth through research and innovation in the middle term; making best use of EU structural funds to enhance investment, innovation, and employment.

Economic growth and growth potential

Before the crisis, Romania recorded high GDP growth rates, which turned out to be unsustainable in view of emerging imbalances. Annual real GDP growth averaged 6.5 % in 2001-08 (Graph 1.1), mainly due to strong domestic demand. Both private consumption and investments flourished, initially fuelled by financial deepening and a credit boom. Additionally, an expansionary pro-cyclical fiscal policy sustained growth. The growing levels of imports generated substantial external imbalances (see next section), which were financed by volatile capital inflows.

Graph 1.1: Real GDP growth by demand components

Source: European Commission

With the onset of the crisis, foreign private capital inflows declined sharply. This decline reflected both the increased risk aversion of financial markets and Romania’s vulnerabilities. It led to an external funding gap that was eventually closed by borrowing under a joint EU/IMF/World Bank financial assistance programme. The reduction in foreign capital inflows and the correction measures adopted under the programme led to an immediate but contained adjustment in domestic demand and to a quick recovery of economic growth, after a cumulated contraction in economic activity of almost 8 % over 2009-10.

Economic growth has been back in positive territory since 2011 and is forecast to remain robust over 2015-16. Since the crisis, GDP growth has been driven by a gradual recovery of domestic demand and strong exports. Despite a recent acceleration of economic growth, GDP is still below its pre-crisis level (Graph 1.2, expressed in 2010 prices). The pace of real GDP growth is estimated to have slowed down from 3.5 % in 2013 to 3 % in 2014, mainly due to a significant drop in investments. Romania’s economic growth is expected to remain robust in 2015 and 2016, mainly driven by domestic demand and accompanied by a stable labour market. GDP growth is forecast to stay above potential and remain robust at 2.7 % in 2015 and 2.9 % in 2016 based on the Commission 2015 winter forecast.

Graph 1.2: GDP dynamics

Source: European Commission

Further progress is needed in terms of real convergence to the EU average level. The authorities announced the intention to adopt the euro in 2019 but the challenges are substantial. In 2014, Romania fulfilled all the five numerical Maastricht criteria for joining the euro zone. However, as illustrated in Graph 1.3, the country is still well below the convergence level reached by recent euro adopters (i.e. Slovakia, Estonia, Latvia and Lithuania).

Graph 1.3: Income per capita, PPS

Note: * LT & PL estimation based on ESA 95, 100 represents EU average income per capita Source: European Commission

The crisis had a large and lasting impact on the Romanian economy. Potential growth estimates show that recovering to pre-crisis growth rates is unlikely (Graph 1.4). After a large drop in 2009, potential growth has started a timid recovery. It is forecast to reach 2.9 % in 2019; this is 0.5 % lower than the average potential growth in the pre-crisis period (i.e. 1996-2008). In 2009-12, potential growth has been driven solely by capital accumulation, reflecting the high level of investment in the economy. In turn, in 2013 and 2014 investment fell sharply.

The level of investment remains above EU average. Investment accounts for almost 24 % of GDP in Romania as opposed to 19 % of GDP in the EU, in 2013. However, the contribution of investment to the overall competitiveness and growth potential is hampered by instable priorities over time for public investment, which represents almost 20 % of total investment (or 5 % of GDP). Ensuring efficient investments in public infrastructure is an important challenge for the Romanian economy. Developments in investment and implementation of the structural reforms announced under the current (precautionary) balance of payments assistance programme have an impact on the convergence process.

Total factor productivity is projected to gradually increase in the next years while growth contributions from labour are broadly neutral. This should come as a result of the labour and product market reforms started under the previous two balance-of-payments programmes. However, reforms have slowed down lately, limiting the increase in potential growth.

Graph 1.4: Components of potential growth

Source: European Commission

Price developments

Inflation was persistently high in Romania but has been decelerating sharply. The high pre-crisis levels of inflation were not reverted with the 2009 crisis. A succession of upward price shocks resulted in inflation levels well above those in the EU. A sharp drop during the 2008-09 crisis was followed by strong price increases. In 2011, significant increases in indirect taxation led to an inflation peak of 8.5 % (Graph 1.5). A temporary decrease at the beginning of 2012 was soon reverted, due to the pressure from rising food prices in the second half of the year and phasing-out of administrative prices in 2013.

Following a sharp decrease in 2014, inflation is forecast to remain moderate in 2015-16. After reaching an historical low of 0.9 % in June 2014, HICP inflation slightly picked up in recent months. Annual average inflation declined from 3.2 % in 2013 to 1.4 % in 2014 mainly reflecting a VAT cut for bread, a good harvest and lower global energy prices. It is forecast to remain at moderate levels and to reach an annual average of 1.2 % in 2015, mainly due to the significant decline in energy prices, subdued inflation in the EU and lower inflation expectations. Inflation is forecast to accelerate to 2.5 % in 2016 as the recovery in domestic demand continues.

Graph 1.5: Inflation

Source: NSI, European Commission

Labour market developments

The labour market shows signs of improvement in 2013 and 2014. Employment and activity rates in Romania continue to be among the lowest in the EU. The employment rate for the 20-64 age group stagnated in 2013, but then increased to 67.4 % in the third quarter of 2014. The recovery is forecast to continue in 2015 and 2016, supported by stronger GDP growth as compared to 2014. It will however still remain below the current EU average of 69.8 %.

Unemployment levels have been relatively stable also during the crisis. Romania’s unemployment rate has been hovering around 7 % for a long period, including during the crisis. This is below the average of its peer group and of the EU (Graph 1.6), but Romania also records a lower activity rate. The unemployment rate increased in 2013 to 7.3 % but decreased again to 6.7 % in 2014 and is expected to further decrease somewhat in 2015 and 2016.

Graph 1.6: Unemployment rates

Source: European Commission

Public finances

Fiscal imbalances have gradually unwound as the budget deficit followed a decreasing path. Before and at the height of the crisis, Romania exhibited twin fiscal and current-account deficits, both exceeding 8 % of GDP. With the support of three consecutive EU/IMF programmes, Romania managed to reduce the budget deficit to 1.8 % of GDP in 2014 (according to the Commission 2015 winter forecast). The adjustment was frontloaded but spread over various years, with a reduction from 8.9 % in 2009 to 5.5 % in 2011 and to 3.0 % in 2012, when the Excessive Deficit Procedure was abrogated. Following a good outcome in 2013, the adjustment has slowed down in 2014. The 2015 deficit is forecast to be at 1.5 % of GDP. This is estimated to be in line with a structural deficit of 1.25 % of GDP, which corresponds to the target agreed under the balance of payments programme for Romania: reaching the medium-term objective of a deficit of 1.0 % of GDP in structural terms plus a so-called EU funds adjustor of 0.25 % of GDP. The latter is an additional budget allocation to be used only for a significant acceleration of EU funds absorption. Furthermore, Romania is adopting measures to strengthen fiscal governance. Public debt increased from 13.2 % of GDP in 2008 to 37.3 % of GDP in 2012, driven by high budget deficits and a contraction in output. Public debt is forecast to plateau out in 2015-16 at around 39 % of GDP as a result of the reduced deficit and the economic recovery.

Graph 1.7: Government deficit and debt (2006-16)

Source: European Commission

The tax mix has improved over the years, but tax policy is changing frequently and revenue collection remains weak. Over the past years, indirect taxation, such as VAT and excise duties, has gained weight in the tax mix. The tax wedge was reduced in 2014 by a cut in social security contributions of 5 pps. across the board, after an increase by 3 pps. in 2009. However, frequent changes in tax policy continue to disrupt the business environment. Tax collection remains weak, and the VAT gap is the biggest in the EU27, at 44 % of GDP in 2012.

The expenditure side still includes significant inefficiencies which weigh on Romania’s growth potential. Domestically financed investment projects sometimes lack thorough preparation, economic justification and steady financing. EU funds’ absorption is lagging behind, at only 52.2 % of the available structural and cohesion funds as of end-2014. Increasing public investment capacity remains a challenge. This is notably due to insufficient shift away from domestically financed projects towards projects co-financed with EU funds. Public investment efficiency also suffers from weaknesses in public investment management. The public wage bill remains contained, but the unified wage grid across the public sector is still not implemented (see section 4.1).

Court rulings and loss-making state-owned enterprises pose risks regarding future budget deficits. Unforeseen court rulings with significant budgetary impact were common in past years. Anticipating possible legal risks ahead remains a challenge. Some state-owned enterprises and other companies reclassified in the general government contributed to the budget deficit, which reflects inefficiencies and weak corporate governance (see section 3.2).

Continued fiscal adjustment and sustainable public debt contribute to comfortable financing conditions. Romania lost access to international financial markets in 2009, requiring EU/IMF financial assistance, but regained market access quickly. Since 2011, Romania is fully financing its deficit and debt on the financial markets. In 2013, JP Morgan included Romania’s treasury bonds in its emerging market index. All three major rating agencies rank Romania at investment grade (Table 1.1) and credit default swap (CDS) spreads are at their lowest levels since mid-2007 (Graph 1.8). Still, market conditions have proven sensitive to deteriorating market sentiment. Both announcements of tapering by the Federal Reserve and the early 2014 financial turmoil in Turkey have immediately impacted financing conditions and put pressure on the exchange rate.

Table 1.1: Evolution of long-term ratings

Source: European Commission

Graph 1.8: CDS spreads over BUND

Source: European Commission

Financial sector

Romania’s financial sector is bank-based and 80 % of the banks are foreign owned. Overall, credit institutions hold the largest share of the financial system’s assets (roughly 80 %) (Graph 1.9). Banks with Austrian capital have dominated the market since 2000, followed by French and Greek banks.

Graph 1.9: Banking assets evolution (2000-13) and composition by ownership

Source: National Bank of Romania (NBR), annual reports

The Romanian banking sector has weathered well the economic and financial crisis and capitalisation remains strong. No public intervention measures to support the banking sector were needed. Non-performing loans declined from 22.6 % in March 2014 to about 14 % in December 2014 (see Graph 3.5 in section 3.3). Moreover, the risks associated with high non-performing loans have been mitigated by the prudent loan-loss provisioning policy of the banking supervisor.

Provisioning for impaired assets is weighing on banks’ profitability. Against the backdrop of increasing loan-loss provisions and high funding costs (in particular for banks with Greek and Cypriot capital), banking sector profitability came under pressure over the last years (Graph 1.10). After three years of losses, in 2013 the banking sector recorded a modest aggregate profit. In 2014 banks' profitability suffered again due to measures implemented for the clean-up of banks' balance sheets under the non-performing loans' resolution plan of the National Bank of Romania. According to preliminary data, the sector recorded a loss of RON 4.3 billion at the end of December 2014.

Graph 1.10: Profit ROA and ROE

Source: NBR

Credit growth remains subdued due to both supply and demand factors. In line with regional trends, in 2014 the Romanian banking system experienced a further contraction in the loan stock, a decline in parent bank funding, and an expansion of the local deposit base, the latter due to precautionary savings by both households and companies. On the back of these developments, the funding gap was also reduced. The loan-to-deposit ratio declined to just below 100 % at end-July 2014 for the first time after almost seven years and to 91.4 % at end-December 2014.

Foreign bank deleveraging has continued in 2014. During the first balance of payments assistance programme (2009-11), foreign-owned banks maintained their exposure to Romania in the framework of the Vienna Initiative. Since spring 2011, however, there has been a gradual and orderly deleveraging with the exposure of these banks declining by about 25 % as of June 2014, compared to March 2009.

The main vulnerabilities and challenges faced by the banking sector have been mitigated so far, but pockets of vulnerability remain. The main challenges regard: (i) the still significant level of non-performing loans; (ii) ongoing but orderly deleveraging; (iii) substantial share of foreign-currency-denominated loans; (iv) legislative initiatives which may have an adverse impact on financial sector stability; and (v) geopolitical risks potentially impacting the parent banks of the Romanian affiliates (see section 3.3).

Box 1.1: Economic surveillance process

The Commission’s Annual Growth Survey, adopted in November 2014, started the 2015 European Semester, proposing that the EU pursue an integrated approach to economic policy built around three main pillars: boosting investment, accelerating structural reforms and pursuing responsible growth-friendly fiscal consolidation. The Annual Growth Survey also presented the process of streamlining the European Semester to increase the effectiveness of economic policy coordination at the EU level through greater accountability and by encouraging greater ownership by all actors. In line with streamlining efforts this Country Report includes an in-depth review — as per Article 5 of Regulation no. 1176/2011 — to determine whether macroeconomic imbalances exist, as announced in the Commission’s Alert Mechanism Report published in November 2014. This Country Report includes an assessment of progress towards the implementation of the 2014 country-specific recommendations adopted by the Council in July 2014. The country-specific recommendations for Romania concerned the EU/IMF financial assistance programme implementation, budget, taxation, pension and health system, labour market, social policies, public administration, energy, transport and EU funds’ absorption. || || So far, the surveillance of imbalances and monitoring of economic policies in Romania has taken place under the balance of payments adjustment programme, which is supported by precautionary financial assistance. However, since the agreement of the arrangement in autumn 2013, no semi-annual review of the programme has been successfully completed and the programme is set to end by September 2015. In autumn 2014 it was deemed useful to integrate Romania in the Macroeconomic Imbalance Procedure surveillance. In addition to regular programme review missions, the Commission’s assessment in this Country Report is based on the December bilateral meetings with the Member State and the associated reporting on the implementation of the 2014 country-specific recommendations. Furthermore, the Commission carried out in January 2015 a fact-finding mission for the purpose of the in-depth review, which ran in parallel with the balance of payments review mission. Country Reports provide the basis for the recommendations that the Council will address to Member States in June. The earlier publication of the Commission’s assessment this year will allow time for more detailed discussions and strengthen the multilateral nature of the European Semester. This will help to advance Europe’s reform agenda. ||

Table 1.2: Key economic, financial and social indicators

(1) domestic banking groups and stand-alone banks. (2) domestic banking groups and stand-alone banks, foreign-controlled (EU and non-EU) subsidiaries and branches. (3) Real effective exchange rate Source: European Commission

Table 1.3: MIP scoreboard indicators

Flags: e: estimated. p: provisional. (1) Figures highlighted are those falling outside the threshold established in the European Commission’s Alert Mechanism Report. For REER and ULC, the first threshold applies to euro area Member States; (2) Figures in italics are calculated according to the old standards (ESA95/BPM5); (3) Export market share data: total world exports are based on the fifth edition of the Balance of Payments Manual (BPM5). Source: European Commission

Net international investment position

The net international investment position of Romania has substantially improved since 2012. Romania had a net international investment position of ‑58.3 % of GDP at end-July 2014, which is the lowest value since the first quarter of 2010 (Graph 2.1.2) and a significant improvement as compared to -67.5 % of GDP in 2012, when the NIIP hit a historical low. This correction comes as a result of strong nominal GDP growth and a low current-account deficit (Graph 2.1.2), in spite of a deteriorating investment income balance and negative valuation effects.

A negative net international investment position is not unusual for a catching-up economy. Peer countries face similar or, for the most part, even more negative net international investment positions (Graph 2.1.1). Those most exposed in the peer group (Hungary, Bulgaria and Latvia) started reducing their international exposure earlier than Romania, possibly as a reaction to nervous international financial markets. Still, an elevated negative net international investment position makes a country more exposed to sudden stops or reversals of capital flows. It also feeds back into the current account through higher net-income deficits, as in the Romanian case (Graph 2.1.1). Moderate current-account deficits can thus help to keep the net international investment position in control in the long run.

Graph 2.1.1: NIIP in Romania and peer countries

Source: European Commission

Graph 2.1.2: Decomposition of rate of change of NIIP

Source: European Commission

In the expansionary years prior to the crisis the deterioration of the net international investment position was financed in part from rather volatile sources. A considerable part of the financing of the net international investment position stemmed from volatile or easy-to-retrieve sources, such as portfolio investments and loans, exposing Romania to financial market risk (see Graph 2.1.3 and section 3.3). The sudden deterioration of market sentiment during the global economic crisis put significant strain on public borrowing and the exchange rate, leading to a significant external funding gap that in early 2009 was eventually closed by a joint EU/IMF financial assistance programme of about EUR 20 bn. Together with the decision by the international banks to maintain their exposure to Romania, under the Vienna Initiative, this financial support and the economic adjustment triggered by the balance of payments assistance programme helped towards a gradual unfolding of Romania’s imbalances.

Graph 2.1.3: NIIP financing

Source: European Commission

The composition of the net international investment position confirms the persistence of volatile financing sources. Net portfolio investment and the net balance of other investments were -72 % of GDP at end-2013, substantially higher than the -43 % of GDP for net foreign direct investment liabilities. This composition is relatively unfavourable compared to regional peers.

Foreign direct investment is, however, recovering its role as a stable source of funding. From a record low of 17 % of GDP in 2002, the net stock of inward foreign direct investment increased steadily in Romania until 2009, to just above 40 %. In flow terms, foreign direct investment has declined sharply from the onset of the financial crisis. Foreign direct investment inflows fluctuated between 1.3 % and 1.9 % of GDP in 2010-13. This is well below the average of 7.4 % of GDP over 2004-08. Consequently, inward foreign direct investment stocks have increased only slightly since 2009, to 43 % of GDP at end-2013. Given the evolution of the net international investment position, this means that, before the crisis net foreign direct investment financed a decreasing proportion of the net external position: falling from 94 % of the net international investment position in 2005 to 66 % in 2009. Since 2011, however, this share has been rising again, reaching 69 % in 2013. The trend reversal is only partially due to the lower negative net international investment position.

Current-account developments

Romania’s current-account deficit decreased in recent years. It has rebalanced from a deficit of over 10 % of GDP in 2006-2008 to around 1 % of GDP in 2013. The adjustment took place in two steps (Graph 2.1.4). In 2009, the current account deficit adjusted to 4.2 % of GDP, mainly driven by lower imports. Following a period of stability, the deficit dropped again in 2012-13 to 1.1 % of GDP. This second adjustment was broader in scope. It resulted from strong exports, stagnant imports and a decrease in (negative) primary incomes. The strong export growth, and increasing services trade surplus is indicative of the structural change in the Romanian economy (see below). The current account surplus is estimated at 1 % of GDP in 2014 and to stabilise in 2015 and 2016.

Graph 2.1.4: Current account balance by components (4qma)

Source: European Commission

Lower government financing needs and corporate deleveraging helped the current-account adjustment that started in 2009. With the unfolding of the crisis, non-financial and financial corporations in Romania increasingly adjusted their balance sheets, turning previously growing borrowing needs into surpluses (Graph 2.1.5). In the financial sector much of the adjustment is attributed to the reduction of exposure of the foreign parent banks to the Romanian banking sector. Additional factors supporting the readjustment process were the successive EU/IMF assistance programmes, which reduced the government's financing needs and ensured underlying structural reforms.

Households did not exhibit the same adjustment capacity. Strongly exposed to foreign-currency denominated mortgage-backed loans (see section 2.3), households saw their external negative balances growing both as a percentage of GDP and as a percentage of their disposable income. These developments are further discussed in section 2.3.2.

Graph 2.1.5: Net lending by sector

Source: European Commission

A comparison with regional peers shows that the current-account adjustment of Romania fits in a wider pattern while being more gradual. Like that of most countries in Central and Eastern Europe, Romania’s current account adjusted sharply in 2009, which was made necessary by the correction of international financing flows. The joint EU/IMF assistance programmes allowed Romania in the following years to undergo a more gradual adjustment (Graph 2.1.6) and thus to limit temporary or even permanent losses of growth.

Graph 2.1.6: Current-account balance in peer countries

Note: BG in 2008, 22.7 % of GDP Source: European Commission

Exports have been the main driver of the recent improvement in the current account balance. Exports grew sharply in recent years, to reach a record high of 41 % of GDP in 2013 (Graph 2.1.7), against 27 % of GDP in 2008 and 2009. Imports, in turn, have been largely stable, at around 42 % of GDP. Both goods and services have contributed to this result, but the evolution of the latter was more noticeable (Graph 2.1.4). In 2013 alone, services contributed 0.9 pp. of GDP to the reduction of the current account deficit. This positive development is partly due to improvements in data collection introduced in 2013, which had a positive impact on the services balance, suggesting that past current account deficits were moderately overestimated. Future growth in services’ exports may be negatively affected by the ensuing basis effect.

The growth of exports translated into strong gains in export market shares. Romania’s market share grew on average by 4.6 % per year in the decade 2004-13. Romania was a top performer among EU Member States in 2013, recording almost 15 % growth in export market share (Graph 2.1.8). Market share growth was stronger for services (6.9 % per year in the period 2004-13) but also important for manufacturing (4.1 % per year) (Graph 2.1.9).

Graph 2.1.7: Romanian exports and imports

Source: European Commission

Graph 2.1.8: Growth in export market shares in the EU

Source: European Commission

The improvement in Romania’s current account is structural in nature. The current-account balance used to exhibit a strongly negative correlation with the output gap during between 2002 and 2009, revealing that the built up of the strongly negative current account was driven by booming internal demand. However, in recent years this correlation did not hold anymore, indicating that the improvement is not only driven by cyclical factors (Graph 2.1.10). In addition, cyclical and non-cyclical current-account balances as percentage of GDP converge towards a balanced level since 2012 (Graph 2.1.11).

Graph 2.1.9: Export market share decomposition

Source: European Commission

Graph 2.1.10: Current account balance and output gap

Source: European Commission

The improvement in Romania’s current account has been accompanied by a readjustment in the exports’ structure. Exports of food and agriculture products have experienced the highest growth rates since the crisis (Graph 2.1.12). Together with vehicles and machinery and electrical equipment, they represented 58 % of Romania’s total exports of goods in 2013. At the same time, sectors such as textiles and footwear suffered a sharp drop in their exports, a trend that started well before the crisis. Metal products have also been losing weight. As for the exports of services, the strong performance is largely due to transportation and business services. For the latter, this may also reflect the good performance of goods exports.

Graph 2.1.11: Cyclical and non-cyclical CAB

Source: European Commission

The current account deficit is expected to widen in 2015-16 to around 1 % of GDP. Strong domestic demand is expected to boost imports faster than exports. This was already apparent in the first nine months of 2014, with exports above expectations (9.1 % growth year-on-year) but still being outpaced by imports’ growth (9.6 % year-on-year).

The EU is the destination for 70 % of Romania’s exports. The proportion of exports going to the EU has decreased somewhat since Romania joined in 2007. This evolution is due to the sharp decline of exports to Italy, from 17 % in 2007 to 12 % in 2013 (Graph 2.1.13). Other EU countries only partially compensated for this. Outside the EU, the most relevant markets are neighbouring countries: Turkey, the Russian Federation, Ukraine and Moldova, but in this group only Turkey has a share above 5 %.

Graph 2.1.12: Evolution of exports by groups of products

Source: European Commission

Graph 2.1.13: Evolution of exports for selected destinations

Source: European Commission

Romania’s exports to its main markets followed a divergent pattern. In 2007, Germany and Italy had the same share of Romania’s exports of goods (17 % of the total). In the following years, exports of clothing and footwear to both countries dropped significantly. In the case of Germany, this was more than offset by higher exports of machinery and electrical equipment, and of chemical products, bringing its total to 19 %. There was no such substitution of exports to Italy, so the proportion of Romania’s goods exports to Italy dropped to 11.5 % (Graph 2.1.14). These developments also reflect broader trends in Europe, including a rapid increase in intra-industry trade and Germany’s strong position in this regard.

Graph 2.1.14: Exports to Germany and Italy, by groups of products

Source: European Commission

Current transfers have remained broadly stable over the past years, while the balance of net incomes has deteriorated in 2013. Private transfers, mostly remittances from the Romanian diaspora, accounted for 73 % of net current transfers in 2013. They have remained relatively stable over 2010-13, even if apparently aligned to the business cycle in the euro area. The remaining current transfers, linked to EU structural funds’ absorption, have somewhat increased at the end of 2013 and at the beginning of 2014, but slowed down again since then.

The balance of primary incomes somewhat decreased. It fell from -1.2 % of GDP in 2010 to ‑2.7 % of GDP in 2014, as dividends and interest from foreign direct investment have increased sharply due to an improved macroeconomic environment and higher corporate profits. Further increases in dividends and interest from foreign direct investment are forecast, as the economy is expected to continue growing above potential. Such a primary income balance is typical for a catching-up economy with high shares of foreign capital (Graph 2.1.15).

Graph 2.1.15: Balance of primary incomes

Source: European Commission

Cost competitiveness

Romania’s cost competitiveness improved between 2009 and 2012, but deteriorated somewhat in 2013. Following years of strong growth, unit labour costs-based real effective exchange rate decreased sharply in Romania in 2009 (Graph 2.1.16). It results from the nominal devaluation and lower compensation per employee. At least some of the recent trade dynamism can be linked to this favourable cost development. In this context, the real effective exchange rate appreciation in 2013 could prove a turning point, especially since shifts in competitiveness usually affect trade performance with a lag. Whether that will be the case depends on the evolution of unit labour costs and on the dynamism of Romania’s tradable sector in terms of non-price competitiveness.

Unit labour costs' growth is slowing down but is still higher than in peer countries. Since the financial crisis, unit labour costs have recorded historically low growth rates in Romania (Graph 2.1.18). Subdued compensation per employee (in 2009-12) and productivity gains (in 2013) explain this reduction. They did, nevertheless, continue to grow above those of Romania’s main competitors (Graph 2.1.18).

Graph 2.1.16: REER decomposition

Source: European Commission

Unit labour costs in the tradable sector are faring better than in non-tradables. The aggregated unit labour costs are pushed upwards by the non-tradable sector (Graph 2.1.17), where productivity gains were insufficient to compensate for increases in labour costs. In the tradable sector, productivity gains and contained labour compensation converged to restrain unit labour costs. Consequently, sectors exposed to international competition were able to retain competitiveness, with a positive impact on the trade balance. However, the increase in unit labour costs in the non-tradable sector poses a risk of higher costs in protected sectors feeding into the costs of tradables, eroding Romania’s international competitiveness.

Competitiveness improvements over 2008-12 came to a halt in 2013. When corrected for export prices, Romania’s unit labour costs-based real effective exchange rate shows a substantial improvement since 2007. This ratio can be seen as a proxy for profitability of exporting firms. The adjustment was stronger in Romania than in the peer group and the EU as a whole, suggesting strong competitiveness gains. This indicator warns, however, that 2013 may have been an inversion point.

Wage growth has been moderate but uneven, with the wage distribution becoming increasingly compressed at the bottom due to strong increases in minimum wages. The minimum wage in Romania is RON 975 (around EUR 217) as of 1 January 2015 and used to be low also in relative terms (36.3 % of average gross earnings in 2013). It has been increasing sharply since 2012 and is expected to reach close to 48 % of average gross earnings at the end of 2016. During 2009-2012, the minimum wage has increased cumulatively by 17 %, against an increase in the consumer price index by 16 %. Over the same period, the average wage increased by 19 %. Growth in the last two years followed a period of roughly no increase in real terms, and this increase has so far not reverberated at the higher levels of the wage distribution. However, this implies that wage scales in different sectors (including in the public sector) are being increasingly compressed and the proportion of employees earning the minimum wage is reaching high levels (27 % of total employees at the end of 2014, a substantial increase from the 8 % registered in 2011). With the planned increases for 2016, to RON 1200, the share will further increase.

Graph 2.1.17: ULC in tradable and non-tradable sectors

Source: European Commission

Minimum wage setting processes are not following a clear and transparent mechanism. According to the Romanian Labour Code, the gross minimum wage is established through a government decision, after consultation with social partners. Prior to the abolition of the national level of collective bargaining with the reform amendment of the Labour Code and of the new Social Dialogue Law in 2011 a number of terms of employment and working conditions including a national minimum wage floor (different from the statutory minimum wage set by the government) and a grid with coefficients depending on qualifications were negotiated and set by a national collective contract which covered all employees in the country. No explicit guidelines exist with respect to the criteria to be followed. Changing the minimum wage without properly taking into account underlying economic and labour market conditions does not ensure a balance between facilitating employment and competitiveness, on the one hand, and safeguarding labour income on the other. In particular, it can pose risks in terms of increased pressure on the overall wage distribution, pushing less productive workers into unemployment and informality and distorting education and skills’ wage premia. Discretionary increases can also contribute to making the business environment less predictable. The Romanian authorities are reviewing the wage setting mechanisms in place in other EU Member States, and are planning to table a discussion with the social partners on the criteria to be followed in setting the minimum wage in the course of 2015.

Graph 2.1.18: Decomposition of ULC

Source: European Commission

Graph 2.1.19: REER vs. export prices

Source: European Commission

Labour productivity in Romania is the second lowest in the EU. Romania faced a decrease of around 4 % in labour productivity during 2008-10, and fell by an additional 0.5 % during 2011-12. In 2013 labour productivity grew by almost 5 %, providing the first clear indication of an improvement (Graph 2.1.21). The labour productivity losses of the last years can be seen as an indication of the low level of adjustment capacity in the economy.

Graph 2.1.20: Labour productivity per hour worked (EU27=100)

Source: European Commission

The structural adjustment between 2008 and 2012 had unequal productivity benefits. The decomposition of labour productivity growth rate (Graph 2.1.22) shows that the sectoral redistribution of resources in the economy favoured less productive sectors and pulled down aggregate productivity performance by 10 percentage points (7.6 percentage points from the shift effect and 2.3 percentage points from the interaction effect). The shift of resources in sectors with high productivity or high productivity growth (within effect in Graph 2.1.22) made a positive contribution of around 5 percentage points, which was not enough to balance the overall productivity losses of -5 %.

Graph 2.1.21: Labour productivity in Romania 2008-2013

Source: European Commission

Manufacturing and real estate are the sectors with the highest within-sector productivity improvements and thus positive contribution to the aggregate labour productivity. Productivity improvements are also observed in trade, transport and accommodation, in construction and in professional, scientific and technical activities (Graph 2.1.23). Productivity in the agricultural sector is low, and it has followed a decreasing path in the recent years.

Graph 2.1.22: Decomposition of aggregate labour productivity growth

Note: Shift effect, indicates the effect of the reallocation of resources to sectors with different productivity levels. Interaction effect, indicates the effect of the reallocation of resources to sectors with different productivity growth rates. Within-sector effect, indicates the effect of productivity gains/losses in each sector of the economy. Source: European Commission

Graph 2.1.23: Productivity gains/losses due to changes in sectoral productivities (within effect)

Source: European Commission

Non-cost competitiveness

The somewhat lower dynamism of Romania’s main geographic and product markets has been counterbalanced by market share gains in these markets (Graph 2.1.25). The geographic specialisation was rather a hampering factor for Romania’s exports while the product specialisation was rather neutral. The exceptionally good results in 2013 can only partially be explained by the improved economic conditions in Romania’s main markets (see Graphs 2.1.24). Even in such a good year, the contribution of specialisation to market share gains was negligible. In turn, Romania was able to gain market shares in these markets.

Graph 2.1.24: Dynamism and competitiveness of exports (goods) in top-10 destinations, 2012-13

Source: European Commission

Over the last decade, manufacturing moved up the respective value-chains, but progress may have stalled. In 2013 manufacturing as a proportion of total value added in Romania was the second highest in the EU (25 % of gross value added comparing to 15 % in the EU). Manufacturing also plays an important role as the main driver of exports.

The revealed comparative advantages indicator suggests an increase in intra-industry trade. Usually this is associated with more integrated production chains (Graph 2.1.26). However, the import content of exports has been dropping in almost every sector, which suggests rather less integration into international production chains (Graph 2.1.27).

Graph 2.1.25: Geographical and sectoral composition of nominal USD rate of change of goods exports

Source: European Commission

Graph 2.1.26: Revealed comparative advantages (goods)

Source: European Commission

High-tech products’ share of total exports increased sharply as compared to a decade ago, but recent trends are less positive (Graph 2.1.29). After peaking in 2010, the high-tech products’ share of exports fell in 2013 to its 2008 level, lower than in all other EU Member States except Bulgaria.

Graph 2.1.27: Import content of exports

Source: European Commission

Graph 2.1.28: High-tech products as a proportion of exports in peer countries

Source: European Commission

Romania lags behind other EU Member States in terms of research and development and innovation capacity. Businesses’ expenditure on research and development was equivalent to 0.19 % of GDP in 2012, seven times below the EU average. It fell further in 2013, to 0.12 % of GDP (despite the existing tax incentives for eligible research and development costs). The underfinancing in the research and development affects the system in structural terms, resulting in a brain drain and decreased quality of human skills. Romania is also among the worst performers in the innovation union scoreboard and the only EU Member State not having registered any improvement in this indicator between 2008 and 2013. The government has adopted a number of policy measures to increase the economy’s capacity for research and innovation. A number of these are, however, not yet fully operational or are rarely used. The cooperation between the public and the private sector in research is also weak. The low level of investment in research and development stands in contrast to relatively high level of total investment in the country.

Graph 2.1.29: Share of high-tech products in exports

Source: European Commission

Gross fixed capital formation spending is among the highest in EU. Gross fixed capital formation was on average 26 % of GDP between 2009 and 2013 (Graph 2.1.30) and remains well above the EU average. The main areas on investment include construction, machinery, and transport equipment, a structure that is typical for middle income countries like Romania. A deepening of the supply chain in machinery and transport might raise technology- and innovation-related investments in the future, but is not yet apparent in the data. Investment in equipment has an average of 10 % of GDP.

Graph 2.1.30: GFCF by type

Source: European Commission

Foreign direct investment

Inward foreign direct investment, as an important long-term source of financing, is diversified in sectoral terms. With a large part of the Romanian banking sector being foreign owned, foreign direct investment in services is a key component of inward foreign direct investment, followed by manufacturing (Graph 2.1.31). Within manufacturing a wide range of sectors profit from foreign direct investment (Graph 2.1.32).

Most foreign direct investment into Romania has its origin in the EU. Statistics on the origin of foreign direct investment are difficult to interpret. In the case of Romania, the Netherlands invest the most, followed by Austria and Germany (Graph 2.1.33). However, these figures may be distorted as many international companies are formally headquartered in the Netherlands, or have the holding company of their European activities in that country.

Foreign direct investment into the tradable sector supports export competitiveness, while credit-boom driven foreign direct investment into the construction sector has been correcting. Since the crisis, inward foreign direct investment in tradables outperformed foreign direct investment in non-tradables. Over 2009-12, the proportion of foreign direct investment into the tradable sectors grew by 1.7 % per year, while that of non-tradables grew by 0.9 %. Reflecting the credit boom correction, the stock of foreign direct investment into real-estate activities and the construction sector fell in 2010 and has stagnated since (Graph 2.1.34).

Graph 2.1.31: Stock of FDI per sector, 2013

Source: European Commission

Graph 2.1.32: Stock of FDI in Manufacturing

Source: European Commission

Foreign-owned companies play a key role in integrating Romania in international trade. In 2013 foreign-owned companies accounted for 67 % of Romania’s exports of goods and 64 % of its imports, being responsible for much of the intra-industrial trade identified above. Manufacturing foreign direct investment alone contributed 58 % of Romania’s goods’ exports and 43 % of its imports, causing a net balance equivalent to 4.1 % of GDP.

Graph 2.1.33: Stock of FDI per country, 2013

Source: European Commission

Graph 2.1.34: FDI stocks in tradables vs. non-tradables

Source: European Commission

Resources

Infrastructure

Romania lacks high-quality infrastructure. Survey results show a much lower satisfaction of economic agents with infrastructure in Romania than in any other EU Member State. Romania has the second worst score in the EU in overall perceived quality of infrastructures (including roads, railroads, air transport, electricity supply and telephony), the second worst score in quality of roads infrastructure and the worst score in railroads (Graph 2.2.1 ). This indicator has slightly deteriorated in comparison to 2007-08.

The underdeveloped basic transport infrastructure continues to be a bottleneck to growth in Romania. The motorways network remains small compared to that of peers, despite the size of the country (Graph 2.2.2) and insufficient against the needs of the economy. High growth of the vehicle fleet and an underdeveloped road infrastructure hamper businesses and the economy. Poor maintenance of the railway network affects service quality, safety and competitiveness of railways. Freight transport on inland waterways remains far below its potential, particularly on the Danube. Limited efficiency and non-transparent governance of state-owned enterprises have hindered the development of network infrastructures, including transport (see below).

Graph 2.2.1: Quality of public infrastructure

Source: World Economic Forum, The Global Competitiveness Report 2014-2015

The development of Romania’s infrastructure is affected by low absorption of EU structural funds. Despite the financing opportunities offered by the EU structural funds, the low absorption rate (see below) and poor strategic management limit Romania’s ability to improve its infrastructure in a sustainable manner. As a result, the elaboration and approval of a transport master plan was made an ex-ante conditionality under the new EU-funds programming period.

The preparation of the General Transport Master Plan is still ongoing. The plan defines the transport strategy for 2014-2030. It maps and prioritises the future transport network by considering the economic sustainability of the infrastructure and the Trans-European Transport core and comprehensive network (as defined in Regulation (EU) No. 1315/2013). There are concerns with political commitment and ownership. Some unsustainable railway lines are still not closed, which affects the system’s efficiency. A commitment to allocate 2 % of GDP to the transport sector has not yet been operationalised.

Graph 2.2.2: Length of motorways, 2012

Source: European Commission

Recent progress with the promotion of competition in energy markets can lead to a more efficient energy infrastructure. Electricity prices for non-households are fully liberalised since 2014 and gas prices for non-households are fully liberalised since the beginning of 2015. In addition, Romania introduced market coupling for its electricity markets.

Set-backs with the liberalisation of gas markets for residential consumers and gas wholesale markets may reduce the impact of other reforms. Romania currently does not have a timeline for the gas-price liberalisation for residential consumers. Also, gas wholesale markets are virtually non-existent, primarily due to the failure to adopt an improved gas code, incentivising gas trading and the limited volumes subject to gas release. The delay in the liberalisation of energy prices for domestic consumers undermines the profitability and attractiveness of energy efficiency investments, for which EUR830 million has been earmarked under ESIF for 2004-2020 programmes.

Romania is one of the most energy and carbon intensive economies in the EU. The CO2 intensity of the economy is more than twice the EU average, while the energy intensity of the economy is among the five highest in the EU. This is partially due to the lack of energy efficiency of the Romanian economy, but also due to the high proportion of energy-intensive industries and the significant proportion of solid fuels in the energy mix. Both policy (e.g. delays in transposition of Energy Efficiency Directive) and implementation limitations are hampering Romania’s progress towards achieving its energy efficiency potential. In the transport sector, for instance, energy consumption has increased at an annual rate of 3 % between 2005 and 2012. Under the Europe 2020 strategy, Romania committed to limiting its greenhouse gas emissions. According to national projections, with existing measures Romania is set to increase its non-Emission Trading System emissions by 2020 by 7 % compared to 2005, staying below its target by a margin of 12 pps.

Broadband coverage is high and with high-speed in the main cities, but it is limited outside urban areas. Broadband take-up is limited and affects the exploitation of digital services, including e-commerce and e-government. Based on most recent data (2013), broadband coverage is available to 90 % of Romanian homes. However, the take-up of broadband subscriptions is the second lowest in the EU. According to Digital Agenda Scoreboard 2014, 58 % of households had a broadband subscription, considerably lower than the EU average of 78 %. The lack of digital skills and affordability are part of the explanation. The potential of e-commerce is still largely untapped in Romania, with the lowest percentage of consumers in the EU buying online and one of the lowest percentages of enterprises selling online ([1]). Consumers’ and retailers’ confidence in domestic online transactions is also below the EU average ([2]).

Financing

Romania does not fully utilise the available funding for investments. Access to finance is the most problematic factor for doing business in Romania according to the World Economic Forum’s 2014-15 report on global competitiveness. Not only EU structural funds, but also banking loans and financial markets proved to be little used. This is due to structural shortcomings of the economy as discussed below, underdeveloped financial markets as well as deleveraging process of the banking system. The latter is further elaborated in the section 3.3. The difficulties with enforcing contracts, including the long average time for court rulings can also be a further disincentive to formal financing channels, even if a positive trend may be emerging on the efficiency of civil justice.

Graph 2.2.3: EU funds absorption in Romania and peers

Source: European Commission, inforegio Cohesion Policy Data

Despite significant progress in 2014, Romania continues to display a low rate of structural funds absorption in the EU. Romania ranks last among the group of peer countries in Cohesion Policy funds' absorption. This is despite the accelerated absorption in the last two years (Graph 2.2.3. Structural funds absorption (excluding the European Agricultural Fund for Rural Development, EAFRD) has continued to progress, from 33.7 % at the end of 2013 to 52.2 % at the end of 2014 of the total structural, cohesion and agricultural funds allocated for the 2007-2013 programming period. The highest absorption rate, 72 %, is observed in the Operational Programme for administrative capacity development. The programmes related to basic infrastructure, such as transport, environment and human resources development managed to absorb 57 %, 42 % and 47 % respectively by the end of 2014 (Graph 2.2.4).

Graph 2.2.4: EU funds absorption per Operational Programme

Source: Ministry of EU funds

Difficulties in implementing the structural funds programmes hamper achieving the objectives of the operational programmes. Besides poor strategic steering, difficulties as regards the implementation of the programmes include: persistent weaknesses in the management systems, failure to proactively anticipate and tackle implementation shortcomings, low coordination between responsible departments, low institutional capacity to implement sectoral strategies, cumbersome national procedures for managing public investment projects, weak financial situation in the construction sector, and persistent shortcomings in the public procurement system. Risk of decommitment of structural and cohesion funds remain for 2015 and at closure in 2017. Due to the insufficient and delayed preparation of the project pipeline, implementation difficulties might arise also in the 2014-20 programming period.

Table 2.2.1: EU Funds absorption rates

Source: European Commission

Access to finance for enterprises remains difficult and expensive, especially for SMEs. Access to finance was identified as the main obstacle for doing business in Romania by the World Economic Forum (Global Competitiveness Report 2014-2015). In 2013, Romania’s performance on the SME access to finance index was the third lowest in the EU, showing a declining trend compared to 2007 ([3]). Even if they have been increasing their exposure to bank lending, only 43 % of SMEs in Romania consider bank loans as relevant for their operation ([4]). This compares with 57 % in the EU, 54 % in Bulgaria, 52 % in Latvia and 50 % in Poland and the Czech Republic. The average interest rate for loans up to and including EUR 1 million is the highest in the EU([5]), and bank loans are often substituted by other, more costly, sources, including credit lines, bank overdrafts and credit cards overdraft. When contracting bank loans, SMEs are also especially affected by bureaucracy, collateral requirements, and low transparency. In the first half of 2014, a government-sponsored attempt to introduce minimum transparency standards for bank-lending conditions did not gain the support of the Romanian Banking Association. The state guarantees scheme for bank lending to SMEs was re-launched in 2014 under more favourable conditions. The procedures are being further shortened and simplified, but the scope of the scheme remains limited.

Capital market funding is limited in Romania. The Romanian capital market is underdeveloped. Big companies do not yet identify it as a source of finance and no alternative market exists for SMEs. There is no appropriate regulatory framework, including investor and entrepreneur protection, for venture capital and other alternative sources of financing. Venture capital investments have fallen by almost 74 % between 2007 and 2012. With a view to developing alternative forms of financing, a law on business angels has been submitted to Parliament. It is expected to be adopted in early Spring. In addition, work is ongoing on legal initiatives on business incubators, credit mediators for SMEs and crowd-funding.

Human capital

Romania is confronted with a shrinking labour force, due to population ageing and outward migration. The population decreased by 7.2 % between 2002 and 2011 ([6]). According to the National Institute of Statistics, 2.3 million Romanians were living abroad in 2013, amounting to about 12 % of the total resident population ([7]). Demographic projections show a steady decline in total and working-age population, coupled with an increasing old-age dependency ratio. The dependency ratio stood at 23.9 % in 2013 and is projected to double around 2050. Such demographic trends are weighing on economic growth over the medium- to long-term. In addition, employment is limited by a low activity rate.

Productivity of the labour force is constrained by a low average skills level and a high skills mismatch. A study on skills mismatch in Europe ([8]) shows only one third of Romanian workers having skills matching their current job. The skills mismatch is also reflected in significant disparities across employment figures by education level. For those with at most lower secondary education (levels 0-2) the employment rate reaches 67 % (2013), and decreases to 56 % for upper secondary education (levels 3-4) while for tertiary graduates the employment rate is 76 %, which is lower when compared to previous years. At the same time companies report difficulties in recruiting skilled labour (30 % of Romanian companies report are facing difficulties in recruiting staff for skilled jobs).

Higher education degrees and vocational education and training qualifications are insufficiently aligned with labour market needs. The relevance of university education for the labour market is a major concern, with limited connection of universities with innovation and research areas and slow adaptation of university curricula and teaching practices to labour market requirements. Participation of adults to lifelong learning is low, especially in the case of adults with lower qualification levels and from rural areas. Furthermore, Romania’s labour force has the lowest level of digital skills in the EU. Based on Eurostat 2014 data, 77 % of the labour force has low or no digital skills compared to 32 % in the EU. The draft Digital Strategy for Romania focuses, among other things, on the development of digital skills, but lacks concrete implementation measures. These developments weigh on labour productivity which in Romania is one of the lowest in the EU (see section 2.1).

Research and innovation

Romania lags considerably behind other EU Member States in terms of resources invested in research and development. The research and development intensity in Romania is the lowest in the EU. This is true for both businesses and public expenditure. Also, recent trends in public research and development expenditure are negative, which is contrary to the Europe 2020 national target of 1 % of GDP spending in public research and development. Research and development expenditure was 0.39 % of GDP in 2013, while business expenditure fell from a rather low 0.19 % of GDP in 2012 to 0.12 % of GDP in 2013. The public research and development intensity decreased from 0.31 % in 2011 to 0.27 % in 2013. In addition, Romania performs far below the EU average in terms of the share of firms that have introduced both technological (34 % of the EU average) and non-technological innovation (63 % of the EU average) onto the market or within their organisations, with a strong decline in 2014 compared to the previous year for the SMEs innovating in-house (see Innovation Union Scoreboard 2014).

Insufficient predictability, as well as fragmented and under-financed institutional setting, affect public policies for innovation and research and development. The capacity of Romania to attract business research and development investment is hampered by the overall low quality of the science base (the lowest in the EU based on the Commission’s composite indicator on research excellence). The lack of predictability and low level of public research and development funding affected the system in structural terms, contributing to a significant brain drain, decreasing the quality of human resources and leading to under-usage of advanced infrastructure available in several research facilities. The high degree of fragmentation of the public research system hampers its efficiency and effectiveness. A comprehensive approach aiming at a possible concentration of institutional resources is not yet being developed. Furthermore, providing SMEs with tailored high-quality services to facilitate innovation remains a challenge in order to improve the firms’ research and innovation capacity.

Business environment

Burden to business

Romania’s business environment is poor and hardly improving. Romania ranks only 48th in the World Bank’s "Doing Business 2015" index (Graph 2.2.6). Romania ranks the lowest among EU countries in a number of key elements for investment, such as dealing with insolvencies, construction permits, registering property or getting electricity, as well as trading across borders (Graph 2.2.6). Additionally, the gap between the EU average and Romania increased from 2008 to 2013 as improvements in Romania did not keep pace with reforms in its European partners. There are exceptions, however: Romania was identified by the World Bank as the economy improving the most in 2013/14 in the ease of paying taxes.

Graph 2.2.5: Ease of doing business

Source: World Bank (2014), "Doing Business 2015"

Entrepreneurship suffers from an unstable regulatory framework. The lack of transparency and predictability of the regulatory framework continue to represent a burden for business. SMEs and start-ups are especially concerned. Although stakeholder consultation is mandatory in Romania, there is no consistent approach to consultations between ministries and procedures are often inefficient and opaque. Impact assessments are presented more like explanatory notes than detailed analysis. The government excessively uses emergency procedures to pass legislation, bypassing the standard legislative procedures. There are also concerns about the lack of consolidations of existing laws and the absence of systematic evaluations to ensure that regulations remain fit for purpose. If effectively implemented, the strategy for better regulation adopted in December 2014 can help to increase the quality of regulation. The new strategy on the business environment for SMEs is also a step in the right direction. However, developing a common methodology for impact assessments was postponed until September 2015 and the introduction of common commencement dates for the legislation affecting businesses is not being operationalised.

Graph 2.2.6: Doing business in Romania

––––

In brackets, Romania’s world rank Source: World Bank (2014), "Doing Business 2015"

Inefficiencies in public administration and corruption represent an extra burden on business. Romania ranks last in the EU in terms of government effectiveness and among the last three Member States in terms of regulatory quality and control of corruption (World Bank, Worldwide Governance Indicators, 2013). Corruption and inefficient government bureaucracy are identified as key obstacles to Romania’s competitiveness by the World Economic Forum (Global Competitiveness Report 2015). Improvements in the public administration can be expected if the Strategy for the Public Administration approved in October 2014 is effectively implemented. In addition to inefficient administrative services, Romania shows a low uptake of e-Government by citizens. According to the Commission's e-Government scoreboard 2014, less than two fifths of citizens use e-government services. The rate of interaction of small enterprises with public authorities is 59 % and lags behind other EU countries (18 pps. below the second last Member State, according to the EC e-Government scoreboard 2014). According to the Digital Agenda Scoreboard, the user-centricity of e-Government services for regular business operations is the lowest in the EU and government transparency the second lowest.

Land planning is a source of uncertainty and costs for investors. The absence of an effective system of cadastre represents an obstacle to the development of infrastructure, property management and consolidation of agricultural land. The status of the land registration agency has been upgraded in March 2014 giving it a degree of self-financing capacity and substantial funding has been allocated for 2015. However, low prioritisation of the project led to slow progress so far. Land-registry remains well behind the target of covering 1/4 of the properties by end-2015, while the absorption of the relevant funds is still low.

Public procurement

Legal uncertainty related to public procurement causes inefficiencies for both public and private actors. The difficulties of the public procurement system in Romania are linked to a combination of several factors. These include the lack of stability and the fragmentation of the legal framework, deficient checks and balances in the institutional system, the quality of competition in public procurement, and the administrative capacity of public purchasers, including the capacity and the degree of expertise of staff dealing with public procurement procedures at both national and local level. The adoption of a Public Procurement Strategy aiming at reforming the current public procurement framework is expected to be adopted within this year.

Addressing corruption and fraud in public procurement remains a challenge. Civil society observers have noted major differences in the number of cases identified and pursued in different parts of the country and by various agencies. Authorities at local level are particularly affected by the lack of transparency in the allocation of public funds and the risks of corruption in awarding public contracts at the local level being substantial (see COM(2015)35 final). The repeated use of exceptions affects the transparency and openness of the market and creates the potential for corruption.

Conflicts of interests constitute a particular concern in public procurement. In 2014, the National Integrity Agency solved a total of 514 cases, out of which 101 concerned administrative conflicts of interests and 60 concerned criminal conflicts of interests. Many of these cases involve politicians and public officials at local level. A system for ex ante checks being developed by the National Integrity Agency ("Prevent") should help to prevent and detect better conflicts of interests. However, problems remain with overlapping responsibilities (e.g. in the field of ex-ante control), insufficient inter-institutional cooperation, and checks and balances leading to inconsistent interpretation of legislation and conflicting decisions of the public procurement authorities. It remains difficult to cancel contracts that suffer from a conflict of interest, especially if they were already totally or partially executed.

Insufficient needs assessment and budgetary planning result in low quality of tenders. The institutional set-up consists of various actors with frequently overlapping responsibilities. Authorities at local level are particularly affected by the lack of transparency in the allocation of public funds to public procurement projects. The central institutions lack the capacity to provide appropriate guidance to the contracting authorities. The repeated use of exceptions affects the transparency and the openness of the market.

The deficient application of public procurement rules triggers substantial financial corrections and contributes to a low absorption of EU funds. There is still a general perception of high levels of corruption, fraud and conflict of interests continuing to raise serious concerns for contracting authorities, which relates to both EU and national funds (see COM (2014) 38 final). 40 % of the complaints related to public procurement in Romania are about public procurement contracts financed by EU funds (see SWD (2015) 8 final). There is a growing number of cases opened and solved by the specialised prosecution services dealing with EU funds ([9]).

Romania has recently started to develop an overarching strategy and an implementation action plan. The strategy would address the quality of the legislative framework, the overall coherence and efficiency of the institutional system, the regularity and quality of the public procurement process, the capacity of the public purchasers, with emphasis on professionalisation and integrity issues and the capacity of the Romanian public procurement system to stimulate effective competition. The strategy and the action plan should be delivered by the Romanian authorities by end June 2015. The related actions and measures should be implemented by the end of 2016.

E-procurement is an important factor for the modernisation of public administration. E-procurement can generate significant cost savings, improve the transparency of public procurement, shorten the time to contract, and increase competition. Pre-award e-procurement is mandatory since 2010 and specific implementation targets have been set for e-submission. Several other phases of procurement have also been made available in electronic format. However, progress appears to be limited and is hampered by the challenges identified for public procurement more broadly.

Fiscal management and fiscal policy stability

A stable fiscal environment could significantly enhance state credibility and confidence in the economy. The Fiscal Responsibility Law as well as the fiscal rules that were introduced in 2010 represent an effort towards credibility, stability and transparency in fiscal management. However, the challenge of proper and timely implementation of the new fiscal management framework remains, since several rectifications have already led to breaches of fiscal rules in 2014.

Some positive steps have been taken to simplify and modernise the tax administration. The reorganisation of the National Agency for Fiscal Administration is still ongoing, aiming to run until end of 2015 to increase flexibility and efficiency in the tax administration. Tax compliance and tax evasion remain important challenges, especially in the areas of VAT, excises and labour taxation (16.2 % of GDP, with the highest shares in the VAT and social security contributions areas, according to Fiscal Council’s Annual Report 2013).

State-owned enterprises

State-owned enterprises play an important role in Romania, dominating economic sectors which are crucial for the overall economy ([10]). State-owned enterprises([11]) generate 8 % of total output of non-financial corporations and employ close to 4 % of the total workforce, whereas government subsidies and transfers to these entities account for 2 % of total government expenditure or 0.7 % of GDP (Graph 2.2.7). State-owned enterprises constitute 44 % of the energy sector and almost 25 % of the transport sector turnover (Graph 2.2.8) which provide crucial inputs to the overall economy.

Graph 2.2.7: Importance of SOEs in the Romanian economy

Source: Ministry of Public Finance 2013 data, Commission analysis

State-owned enterprises absorb a significant share of labour and capital. Combining OECD data on state-owned enterprises with data on Romania, which is not an OECD member, allows for basic cross-country comparison of the state-owned enterprises sector’s share of the national economies and the number of employees as a proportion of total employment (data are not fully comparable, due to exclusion from the dataset of state-owned enterprises at local-government level for some OECD members). Although these ratios are imperfect proxies for measuring the importance of state-owned enterprises in the respective countries, they show that the equity valuation of Romanian state-owned enterprises in proportion to GDP and the Romanian workforce employed in state-owned enterprises are markedly above the average (Graphs 2.2.9 and 2.2.10). The weight of state-owned enterprises in the Romanian economy is thus significantly above the EU average. The prevalence of state ownership in the Romanian economy does not necessarily constitute a source of concern, if it was not for their underperformance compared to other companies.

Graph 2.2.8: Importance of SOEs by sector

Note: Central- and local-government-owned SOEs combined. Other sectors comprises NACE R2 categories C (excl. C20 and C21), G, I, J, L, M, N, P, and Q. The graph does not include NACE R2 categories A (108 SOEs), F (141 SOEs) and R (27 SOEs). Source: Ministry of Public Finance 2013 data, Commission analysis

Graph 2.2.9: Equity valuation of SOEs expressed relative to GDP

Note: Data excludes entities in which the state has a minority stake Source: OECD dataset on the size and composition of national state-owned enterprise sectors, Ministry of Public Finance data Orbis database, 2012 data, Commission analysis

Graph 2.2.10: Employment at SOEs as a proportion of total employment

Note: Data excludes entities in which the state has a minority stake Source: OECD dataset on the size and composition of national state-owned enterprise sectors, Ministry of Public Finance data, 2012 data, Commission analysis

Suboptimal operational performance

The economic performance and financial situation of Romanian state-owned enterprises is worrisome. State-owned enterprises are less profitable (Graph 2.2.11) and less productive, while paying higher salaries than their privately-owned peers (Graph 2.2.12).

Productivity of state-owned enterprises in many sectors remains substantially lower compared to that of private- and foreign-owned companies. Following the approach in a recent World Bank study ([12]), comparisons of the labour productivity levels show that the Romanian state-owned enterprises underperform relative to their private- and foreign-owned peers in chemical industry and utilities. However, they outperform privately-owned companies in other sectors (Graph 2.2.13). In adjusted estimations, a significant underperformance of state-owned enterprises is observed in the chemical industry and Information and Communication Technology. In manufacturing and tourism state-owned enterprises outperform their private-owned peers (Graph 2.2.14). Foreign-owned firms have higher average productivity, especially in terms of labour productivity. Given the substantial role of state-owned enterprises in value added creation in e.g. the chemical industry, underperformance in terms of total factor productivity can imply a substantial cost.

Graph 2.2.11: Return on equity of SOEs and foreign-owned companies compared to domestic privately-owned companies

Note: Analysis based on the Orbis database, in this and subsequent graphs, companies owned by other states are not considered as SOEs for the purposes of this analysis.. Any company in which government(s) have a stake of 25 % or higher is classified in the SOE category. Note: Sectors are defined in terms of NACE R2 categories as follows: agri & mining A-B, chem&phar C19-C21, , ICT H53 & J, other manufacturing C31-C33, other services M-U excl N79 & R, , tourism I, N79, R, transport H excl H53, utilities E. The sectors where SOEs represent less than 5 % of value added are not included, these are construction F and L, durables C25-C30, materials C22-C24, staples C10-C18, trade G. The energy sector (D) has also been excluded as private-owned companies represent less than 5 % of value added. Number of companies included in the database for the specific indicator in parentheses. Source: Orbis database 2004-2013 data, Commission analysis

State-owned enterprises in Romania are also outperformed by their peers in neighbouring countries. Out of four sectors with large state-owned enterprises presence, Romanian state-owned enterprises outperform their peers only in the utilities sector, in terms of profitability (Graph 2.2.14).

State-owned enterprises are contributing to the illiquidity in the economy. In 2012 they accounted for 17 % of overdue payments to suppliers (state-owned and privately-owned combined), weighing on the smooth functioning of the economy.

High indebtedness and low rates of return generate solvency problems for state-owned enterprises. In 2012, the total debt of state-owned enterprises climbed to 7.7 % of GDP. The total operational profit of all state-owned enterprises combined was 0.4 % of GDP in 2013, with a limited number of state-owned enterprises being profitable. The stock of overdue payments on the balance sheets of all state-owned enterprises (including those under insolvency or liquidation procedure) amounted to 3.4 % of GDP at end-2014 (Graph 2.2.15), down from about 5 % of GDP in 2010. The reduction in overdue payments has mainly been achieved involving significant fiscal resources, including a mix of debt restructuring, cancellations of overdue tax liabilities, ad hoc increases in transfers from the government budget, restructuring of companies and liquidations.

Graph 2.2.12: Staff expenses at SOEs and foreign-owned companies compared to private-owned companies

Source: Orbis database 2004-2013 data, Commission analysis

Some of the loss-making companies are performing a public-service obligation. It could be argued that, apart from the need to improve operational performance, another challenge for state-owned enterprises performing a public-service obligation regards receiving adequate government transfers to appropriately cover operational costs linked to the public service obligation.

Many companies, notably CFR Marfa, Tarom and Oltchim operate in a competitive environment. In these cases, EU law strictly regulates the conditions under which they can receive state support, underlying even more the need for improvements in operational performance.

Graph 2.2.13: Labour productivity of SOEs and foreign owned companies compared to domestic privately owned companies

Source: Orbis database 2004-20123 data, European Commission calculations

Graph 2.2.14: Total factor productivity of SOEs and foreign owned companies compared to domestic privately owned companies

Source: Orbis database 2004-20123 data, European Commission calculations

Graph 2.2.15: Payments past due date at state-owned enterprises

Source: Ministry of Public Finance 2014 data, Commission analysis

State-owned enterprises and public finances

Loss-making state-owned enterprises represent a burden to the general government budget. End-2013, state-owned enterprises accounted for 50 % of all tax arrears of companies. One explanation for the high proportion of total tax arrears could be that state-owned enterprises on average are much more loss-making than private sector companies and therefore encounter more difficulties in paying tax liabilities. Another explanation could be that payments of tax obligations are less enforced in the case of state-owned enterprisescompared to private companies. Such preferential treatment would put state-owned enterprises at an advantage vis-à-vis their private sector competitors.

Several state-owned enterprises classified outside general government represent contingent liabilities for the state budget. When sales of a publicly-owned entity drop below 50 % of production costs, the entity is classified into the general government sector (as defined in ESA) and its financial situation impacts directly the government’s deficit and debt levels. State-owned enterprises classified outside general government carried debt levels equivalent to 5.4 % of GDP in 2012, more than two thirds of total state-owned enterprises debt. They had a stock of overdue payments equivalent to 1.9 % of GDP in 2013, more than half of the total stock of overdue payments of all state-owned enterprises together.

In order to avoid job losses through liquidation or restructuring, the Romanian authorities are supporting certain loss-making state-owned enterprises. This is done mostly through foregone tax liabilities and through government subsidies or transfers. Recent examples in 2013 and 2014 include support to the state-owned rail freight operator, the rail passenger operator and the defence industry. Those support measures alone total to 0.5 % of GDP.

Corporate governance

Corporate governance is a key factor determining performance of state-owned enterprises. The management of state-owned enterprises is dispersed across different government entities, with some companies managed by line ministries or central government entities and some managed by local government (local administrative units organised at different local levels: municipalities, cities, counties). Each line ministry has a department supervising the state-owned enterprises under its responsibility. Such a governance structure is not an ideal setup for avoiding political interference in the day-to-day management of the companies, or guaranteeing a separation between the authorities’ ownership and policy-making functions. Moreover, there is no asset management strategy laying down which assets the authorities consider strategic and which assets could be privatised over time, although this could help in reducing the opportunities for vested interests to influence privatisation processes.

General OECD corporate governance rules apply also to state-owned enterprises. General corporate governance principles, as defined by the OECD in 2005 ([13]), were incorporated in the Romanian legislation on commercial companies already in 2006, and are also applicable to most state-owned enterprises as most are organised as commercial companies. Sound corporate governance principles for state-owned enterprises include (i) the separation between the ownership and policy-making function of the government, (ii) full transparency on strategic decisions, related-party transactions and audited financial information, (iii) clarity on public-service obligations versus competitive operations, and (iv) professional and transparent board and management nomination and remuneration processes. Above all, company board members and management need to be able to operate independently from direct government interference, within only the overall strategy set out by the government as the sole or main shareholder.

Graph 2.2.16: Return on equity in of SOEs in selected sectors in Romania and neighbouring countries

Source: Orbis database 2004-13 data, Commission analysis

Specific rules for state-owned enterprises were systematically only introduced through government emergency ordinance 109/2011, but various areas remain uncovered. Government emergency ordinance 109/2011 did not attempt to modify the state ownership setup, nor does it lay down detailed rules for the functioning of boards. Shielding off state-owned enterprises from interference of line ministries is also not tackled through the ordinance. Government emergency ordinance 109/2011 provisions focus inter alia on: (i) selection procedures, appointment and responsibilities of board members and management; (ii) transparency; and (iii) oversight by a dedicated unit within the Ministry of Public Finance. Ceilings for the remuneration levels of state representatives participating in general shareholder meetings and board members are defined in separate government ordinances. Performance monitoring is included, while rules for the enforcement of this monitoring and the improvement of performance are weak. There is thus ample room for improving corporate governance legislation for state-owned enterprises, along the domains spelled out in the World Bank Toolkit of 2014.

The rules laid down in government emergency ordinance 109/2011, although straightforward, are still not fully adhered to. When implemented, selection procedures for managers and board members often adhere to the letter but not to the spirit of the law. One such example is the dismissal of management and board members upon the arrival of a new minister, only to appoint interim managers and board members while a new lengthy selection procedure is started. The monitoring unit within the Ministry of Public Finance lacks proper enforcement tools as line ministers do not feel accountable to this unit. As a result, enforcement rules laid down in the emergency ordinance are not applied to companies not adhering to transparency provisions.

The government emergency ordinance 109/2011 is already binding but will be amended and probably adopted by Parliament. The Romanian authorities, together with the World Bank, are currently performing an assessment of the current text in order to identify potential revisions to enhance transparency, compliance monitoring and enforcement. The Romanian government’s aim is to submit a new draft to Parliament in early 2015.

Restructuring and privatisation

Restructuring and privatisations are an important pillar in the successive balance of payments assistance programmes to Romania. This is due to the large number of state-owned enterprises, their dominance in the energy and rail transport sectors, their suboptimal operational performance and their impact on public finance. Under the programmes, corporate governance legislation specific to state-owned enterprises was introduced in 2011 (through government emergency ordinance 109/2011). In addition, payments past due date were reduced from 5 % of GDP (2010) to 3.4 % (2013). Lastly, five tenders for shares of state-owned enterprises were concluded ([14]). However, out of the 20 companies selected for minority or majority privatisation or liquidation under the balance of payments programmes, 11 procedures are still pending. Only one majority privatisation procedure has been completed, despite a selection of 13 companies.

Overview of the banking sector

Graph 2.3.1: Structure of the financial sector (%GDP)

Note: Investment funds incl. "Fondul Proprietatea" Source: NBR, Financial Stability Report 2014

Similar to other countries in Central and Eastern Europe, the Romanian financial sector is heavily bank-based. Overall, credit institutions hold the largest share of the financial system’s assets (roughly 80 %), followed by non-bank financial institutions and investment funds. In recent years, private pension funds and investment funds are becoming more important in the Romanian financial system. However, the total financial system’s assets as a proportion of GDP decreased over the past years, reaching 81.5 % at year-end 2013 (Graph 2.3.1).

Banks in Romania are mainly invo