First, let the cold figures talk:
The data on GDP evolution in the first half of the year were published at the beginning of September. Subsequently, GDP rose by 0.8% in Q2 against the same quarter of 2023. And if we look at GDP evolution in the first half against last year’s same period, considering raw data (to remove seasonality), the increase was only 0.7%.
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Moving on to high-frequency data, we note that the only significant contribution to GDP increase came from retail consumption of goods, which increased by more than 8% in the first 7 months of the year against last year’s same period.
A drop of 1.5% was recorded in the case of services provided to the population, this indicator being on a slowing trend since it fell by 2.8% in July against last year’s same month.
If we move on to business-to-business transactions, which show a glimpse at future evolutions of retail transactions, we note that these have slowed down. Thus, the turnover in wholesale goods trade fell by 1.4% in the first 6 months of the year compared to last year’s same period. And the evolution is worsening – with a recorded drop of 4.3% in June against last year’s same month.
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The same negative evolution, on a strong downward trend, was recorded by services provided to businesses. Therefore, activity decrease by 0.1% in the first half of the year against the same period of last year, but the decline registered in June stood at 8.4% compared to last year’s same month.
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The drop in the IT sector stands out negatively – by nearly 13% in June against last year’s same month, and by more than 14% against the previous month (but the first half of the year recorded a 4.5% rise against last year’s same period, with an obviously steep deceleration).
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The construction sector also recorded a decline in activity. The decrease in the first half of the year was 2.5% compared to the same period of last year. The decline stood at such a low level thanks to the public sector’s investments in infrastructure which rose by 9.4%. On the other hand, residential construction fell by more than 22%, while non-residential construction shrunk by 2%.
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Meanwhile, if we analyze the budget execution, the budget deficit in the first seven months of the year exceeded 4%. Towards the end of the year the deficit widens faster, while estimates from both the Fiscal Council and the European Commission for this year’s budget deficit are heading towards more than 7%, even 8%.
Moreover, considering the latest data on the balance of payments published by NBR, we see that the trade balance deficit for goods and services soared by more than EUR 2.9 billion (nearly 1% of GDP). The goods deficit swelled by EUR 1.9 billion, while, for the first time in recent years, the surplus in services diminished by more than EUR 1 billion. At the current pace, the current account deficit, fueled by trade deficit, will exceed 7% of GDP.
From these developments, it practically follows that the fiscal impulse that led to an unsustainable budget deficit, heading to 8% of GDP, generated only an overheating of consumption and an extremely low economic growth – probably around 1% of GDP. It generated instead a significant increase in trade deficit.
Essentially, the local supply did not respond to the fiscal impulse, materialized through the increase of public sector wages, but the additional demand was balanced by the supply from imports. Basically, Romania borrowed in order to consume imported goods.
From a demand economy to one of supply: how local supply could be increased
The answer is – through investments.
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Romania is attractive to foreign investors due to low capital taxation and low wages. This is also noted by OECD in its analysis reports on Romania’s evolution. Romania has one of the lowest corporate tax rates and some of the lowest wage levels in the European Union.
Although wages increased in real terms, especially in euros (in the context of the EUR/RON exchange rate stability), they remain among the lowest in the European Union. But a populist attitude towards foreign companies as well as sudden changes in taxation, besides being barriers in the process of joining the OECD, could drive away foreign investors from Romania.
One example of populist policy that will affect long-term economic attractiveness for foreign investors is the governments’ approach to find “fault” in companies, especially in foreign ones, such as “greed”, “exceptional profit”, “indecent profit” or even “lack of profit”, and consequently “feeling obligated” to impose additional taxes on those companies.
But a company decides to invest in a certain location depending on the expected return. And, in order to invest, this return, adjusted with the related risk, must be higher than the return from the market of origin. In financial terms, this additional yield is called “alpha”.
But if the state, for various reasons, takes away this “alpha” from the company through additional taxation, then many companies will lose the motivation to invest. Such approaches to investors in the economy are incompatible with Romania’s membership in the OECD.
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Another example is the discrimination between Romanian and foreign companies.
For example, limiting profits for Romanian products. Any entrepreneur aims to make a profit and, if the state limits the return on their investment, the entrepreneur will lose the aspiration to operate further investments and developments. The more profitable the production in Romania, the higher the investments in production will be.
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Romania’s access to PNRR funds as well as to cohesion funds granted by the European Union facilitates investments in infrastructure (which is absolutely necessary for any kind of subsequent investments) and in other fields such as energy and agriculture.
As a consequence, Romania can access approximately EUR 75 billion by 2027, or more than 3% of GDP every year. This is a unique opportunity for the development of the Romanian economy, an opportunity that Romania will not come across again.
PNRR is a one-off and will not be repeated, and the funds allocated to Romania will probably diminish significantly, considering Romania’s accelerated convergence towards the EU average, as well as the fact that the Union will expand with Ukraine, Moldova and possibly countries from the Balkan region, which will consume a large part of cohesion budgets in the future.
In addition to the allocated funds that contribute to maintaining the rating recommended for investments, as stated by rating agencies, there are also the reforms Romania took on which, if implemented, will contribute to the development of Romanian society and economy.
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Romania is an importer of agricultural products. Romania has high potential in terms of agriculture, it could become a regional player, but, in order to gain external competitive capacity, it requires large-sized farms, capital investments and automation (seeing that Romania is converging towards an economy with high incomes, basing agriculture on cheap labor is an illusion – does anyone remember the lohn-based textile industry?).
For these investments to be made, agriculture must be lucrative. Limiting profits of local producers will in no way lead to additional investments and competitiveness in relation to imported products.
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Romania has a unique situation in Central and Eastern Europe in terms of energy resources. Thus, Romania is practically independent when it comes to natural gas.
Unfortunately, as a consequence of the Ordinance 114/2018 (the so-called Greed Ordinance), Romania lost a great investment opportunity to extract methane gas from the Black Sea, when a large American company in the field of energy left Romania. Romania is also independent in terms of electricity as well and, in addition, in the context of transitioning to renewable resources, benefits from European funds allocated through PNRR and RePower EU for investments in green energy (wind, solar, hydrogen, electric batteries installation). Romania could become an energy exporter with the necessary investments and using this energy independence as a foundation.
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Not least of all, Romania has an important strategic position in the region. And this fact supports logistics services and investments in this sector, especially after the start of the war in Ukraine.
But the support and development of this field requires investments in the transport infrastructure, investments for which European money is also available, from PNRR as well as from cohesion funds. Moreover, Romania joining the Schengen are would help a lot.
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The exchange rate is another factor that led to a diminishment (with a slight influence, but nevertheless noticeable) in the competitiveness of Romania’s economy:
Since 2016, the real effective exchange rate has remained relatively constant, with a neutral impact on competitiveness, with RON depreciating annually along with the inflation differential between Romania and the Euro zone. Still, with the onset of the energy crisis and given the fact that Romania is a net importer of energy, the exchange rate was used as an anti-inflationary anchor and remained relatively constant against the EUR. However, the inflation differential between Romania and the Euro zone led to the appreciation of the RON in real terms. Consequently, when we look at the real effective exchange rate between Romania and Euro zone countries (Romania’s main trading partner), the real appreciation of the RON in the last 2 years (2022 and 2023) stood at approximately 6.5%. It is probable that, with the reduction of the inflation rate, the EUR/RON exchange rate will resume following the inflation differential and hence return to the neutral effect on Romania’s external competitiveness.
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