Financial Markets-Economics“Romania- Ready for lift-off?”

Florin V. Cîţu-Chief Economist

November 2006

Page 2

[Financial Markets]

Roadmap

• Overview of the global economy

• The Romanian economy

• Prices

• Interest Rate

• Exchange rate

• Convergence to the EUR

Page 3

[Financial Markets]

Global economic health

• Strong global growth, at least in the near term

• Emerging markets seem better equiped to deal with any increase in volatility

• Central and EE economies are growing strong

• Banks in the region are booming

• While international imbalances are widening

• And inflationary risks are intensifying

• But reactions from regionals central banks show that risks are closly monitered

Page 4

[Financial Markets]

US to slowdown while EU will grow faster

2.5

3

3.5

4

4.5

5

5.5

1Q05 3Q05 1Q06 3Q06 1Q07 3Q07

0

1

2

3

4

5

6

1Q05 3Q05 1Q06 3Q06 1Q07 3Q07

1

2

3

4

1Q05 3Q05 1Q06 3Q06 1Q07 3Q07

US GDP (%QoQ ann)

US Fed funds EBC refi rate

0

0.5

1

1.5

2

2.5

3

3.5

1Q05 3Q05 1Q06 3Q06 1Q07 3Q07

EU GDP (%QoQ ann)

Source: ING forecasts

Page 5

[Financial Markets]

The regional economic view

• EU enlargement has brought stronger growth

• Central and EE economies are growing strong

• Banks in the region are booming

• Romania’s underbanked economy offers the most potential for credit growth in the near future

Page 6

[Financial Markets]

Growth remains strong

0

2

4

6

8

10

2000 2001 2002 2003 2004 2005 2006F 2007F 2008F

Czech Republic (% YoY)

0

2

4

6

8

10

2000 2001 2002 2003 2004 2005 2006F 2007F 2008F

Hungary (% YoY)

Source: ING forecasts

0

2

4

6

8

10

2000 2001 2002 2003 2004 2005 2006F 2007F 2008F

Poland (% YoY)

0

2

4

6

8

10

2000 2001 2002 2003 2004 2005 2006F 2007F 2008F

Romania (% YoY)

Page 7

[Financial Markets]

Increasing Indebtedness

• Until late 1990s it was not possible for households to be indebted, but now consumers can leverage themselves up significantly – a key factor driving economic growth in the next 5 years. For example, in 1995 in Greece and Portugal private loans/GDP were at 34% and 75% respectively. Ten years later this ratio reached 79% and 150%.

Lending to private sector as % of GDP

0

10

20

30

40

50

Hungary Slovenia Latvia Estonia Bulgaria Czech Republic Slovakia Poland Romania

Page 8

[Financial Markets]

Romanian credit set to grow further

• With few exceptions credit has continued to grow in all EE econmies in the last 10 years. However, in Romania credit has only started to support growth in the last couple of years, but it is likely to pick up pace in the next couple of years.

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

RON FX Priv ate sector

Romania Romania

-10

-5

0

5

10

15

20

25

1997 1998 1999 2000 2001 2002 2003 2004 2005

GDP(% YoY) Private Credit/GDP

Page 9

[Financial Markets]

EE experience supports RON credit growth

New EU members Future EU members

0

10

20

30

40

50

60

70

80

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Len

din

g t

o t

he p

riva

te s

ect

or a

s %

of

GD

P

Czech Republic Estonia

Hungary Poland

Slovakia Latvia

0

10

20

30

40

50

60

70

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004Len

din

g t

o t

he p

riva

te s

ect

or a

s %

of

GD

P

Bulgaria Romania Turkey

Ukraine Croatia

• Except for Czech Republic, where we saw a boom and bust scenario, all the other countries show strong and sustaible penetration of lending into the real economy.

• In the same time of all the furture EU members Romanai is the most underbanked economy and thus has the greatest potential to develope further.

Page 10

[Financial Markets]

Romania offers many opportunies

Lending to the private sector + Gov’t debt (2005)

• Countries with the best outlook are on the right-hand side of this chart and include former Soviet countries as well as Romania and Mexico (even accounting for problems with IMF methodology re: Mexico’s public debt).

0

50

100

150

200

250

300

Jap

an

US

Ne

the

rland

s

Isra

el

UK

Ital

y

Ger

ma

ny

Gre

ece

Ch

ina

Eg

ypt

Cro

atia

So

uth

Afr

ica

So

uth

Kor

ea

Ph

ilipp

ines

Hu

ngar

y

Tu

rke

y

Ind

ia

Bra

zil

Ch

ile

Po

lan

d

Bu

lga

ria

Slo

ven

ia

Co

lom

bia

Slo

vaki

a

Arg

ent

ina

Cze

ch R

epub

lic

Ru

ssia

Ukr

ain

e

Lat

via

Lith

uan

ia

Est

onia

Me

xico

Ka

zakh

sta

n

Ro

man

ia

Lending to the private sector Government debt

(% of GDP)

Page 11

[Financial Markets]

After the EU entry - convergence

• EU enlargement brings stability

• Produces fast growth

• Helped by convergence funds

• FDI is attracted by cheap educated labour force, low tax rates and prospect of EU funding improvements to infrastructure

• Romania’s relatively cheap labor and improving corruption record bodes well for FDI prospects

• Eventual Euro adoption (2012-2014) should secure low interest rates and eventually lower inflation

• But Romania has some way to go to fulfill the Maastricht criteria

Page 12

[Financial Markets]

Convergence funds evolution

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

Dec

-99

Mar

-00

Jun-

00S

ep-0

0D

ec-0

0M

ar-0

1Ju

n-01

Sep

-01

Dec

-01

Mar

-02

Jun-

02S

ep-0

2D

ec-0

2M

ar-0

3Ju

n-03

Sep

-03

Dec

-03

Mar

-04

Jun-

04S

ep-0

4D

ec-0

4M

ar-0

5Ju

n-05

Poland Hungary

Slovakia Czech

• Convergence funds have been established that are dedicated to the convergence trade. Within the €100bn C4 debt market (€50bn Poland, €30bn Hungary, €10bn Czech Republic and €5bn Slovakia – vs €1bn in Romania), the bulk had to be allocated to Poland and Hungary. Holdings have risen from €4bn to €35bn since 1999.

Flow of funds into local debt markets (€m)

Page 13

[Financial Markets]

Maastricht criteria-budget deficit

2006 Budget deficit forecasts ( ING)

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3

Bulgaria

Romania

Czech

Maastricht

Slovakia

Poland

Hungary

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

2001 2002 2003 2004 2005 2006F 2007F

Budget Def icit

Romania

•EU countries in the convergence trade have few problems funding budget deficits, perhaps encouraging high deficits. Romania has acted more responsibly but it shows signs that budget deficit will grow. Although, close to the Maastricht criteria.

Page 14

[Financial Markets]

Maastricht criteria-public debt

2005 Public debt (% of GDP) - Eurostat & ING

0

20

40

60

80

100

Romania Czech Bulgaria Poland Hungary Maastrichtlimit

Eurozone(2003)

Greece (2003)

Both first and subsequent EU enlargement countries tend to have low debt (public debt, external and internal), decreasing the risks of a financing crisis.

Here Romania looks very well, with plenty of room to increase its public debt

Page 15

[Financial Markets]

Maastricht criteria-inflation

Higher inflation in second-wave countries

Interest rates should remain high for a longer period of time

It translate in more real currency appreciation

2005 average inflation

0

2

4

6

8

10

Czech Eurozone Poland MaastrichtEU 25

Slovakia Croatia Hungary Bulgaria Romania

Page 16

[Financial Markets]

FDI-Romania well placed to receive more

Czech/Hungary now look expensive relative to others in the region.

Poland/Slovakia remain attractive for FDI based on lower wages and high labour supply.

Romania far cheaper and has the advantage of low tax rates, but corruption is still a problem and overall competitiveness is lower.

Wages (EUR) 2005E

Unemployment (%) Dec-05

Corp tax Competitiveness (6 = best)

Per capita GDP

(US$)

Under or overvalued (-) currency vs Spain

Corruption (10 = least

corrupt)  

Czech Republic

6.5 8.7 24 4.42 11,800 31 4.3 

Hungary 7.2 7.2 16 4.38 11,600 20 5.0 

Slovakia 5.1 15.5 19 4.31 9,300 23 4.3 

Poland 5.4 17.6 19 4.00 7,600 33 3.4 

Bulgaria 2.1 11.9 15 3.83 3,400 31 4.0 

Romania 2.6 5.8 16 3.67 4,500 11 3.0 

 

Sources: ING, EU Commision 2006 rates World Economic Forum

ING, 2005 data

ING, PPP comparison Transparency International

Page 17

[Financial Markets]

The bottom line

The global economy is expected to grow at a strong pace over the next 6 quarter. IMF has revised upwards it’s world growth for 2006 and 2007

Emerging markets are well placed to grow fast because 1) bank lending will grow, 2) government policies are better and having a positive effect 3) commodity prices are still high, although the latest data shows that they might have peaked

Within Emerging Europe, the EU convergence story adds further lift 1) low external debt spreads, 2) low local interest rates, 3) high FDI flows as manufacturing moves from western Europe to new member states, and services sector expands rapidly 4) EU cash transfers that will be 3-4% of GDP annually

Romania has the opportunity to adopt the Euro by 2012-14, and catch up with central Europe, unless it follows the populist route of central Europe

Euro adoption in six years would support a fairly bullish view on the RON, stability in nominal terms and appreciation in real terms.