No country in the world has ever developed with low salaries

Andrei Radulescu, senior economist for Banca Transilvania, Romania

CE Financial Observer talks with Andrei Radulescu, PhD, senior economist for Banca Transilvania in Romania.

CE Financial Observer: The governor of Romania’s National Bank said in an interview that Romania doesn’t have a chance for another agreement with the IMF in 2016 because of complications in closing the last agreement and also because of the “extremely low current account deficit,” less than 1 per cent. Should Romania be afraid of the lack of cooperation with the IMF in the nearest future?

Andrei Radulescu: 2015 was a reference economic year for Romania. As regards the real economy, all production factors presented a positive contribution to growth — 3.7 per cent y/y, according to the preliminary estimates. In terms of the financial economy, financing costs decreased to record low levels, an evolution reflecting the high degree of macro-financial stability. For the following quarters, the perspectives are mainly positive, either for the real economy or in terms of financial stability — the current account deficit stabilized at record low levels, around 1 per cent of GDP. At the same time, the Romanian economy is less dependent on foreign capital flows and there can be noticed a balanced behavior at the population or corporate levels. In this context, there seems to be no need for a new International Financing Agreement, at least from the short-run perspective — by the end of the year.

Some plans of the new Romanian government, included in 2016 state budget, are in a sense similar those of Poland’s new government – for example, doubling of child benefits (that will cost RON1.8bn). After people’s anger and disappointment accompanying the resignation of Victor Ponta’s government, the new government likes to reward citizens. But can Romania afford it? Especially if doubling benefits is accompanied by increasing healthcare wages by 25 per cent, education by 15 per cent, pensions by 5 per cent and local authority salaries?

Indeed, at present fiscal and income policies are expansionary in Romania. On the other hand, the Romanian economy has important maneuvering room in terms of diminishing the weight of the informal economy. At the same time, the salaries gap between Romania and the EU average continues to be high. No country in the world has ever developed with low salaries — people should be motivated to deliver performance. However, the dynamics of salaries should take into account productivity pace. In this context, we point out that the increase of public wages should be accompanied by a reform of the public administration. Overall, we forecast that the acceleration of the economy together with the “whitening process” would diminish pressure in terms of public finances determined by the New Fiscal Act and by wage increases. Consequently, Romania can afford these measures, but, from the long-term perspective, economic performance, including macro-financial stability, would be improved by speeding up structural reforms.

The Polish government wants to finance benefits through increased taxes, for example by imposing a tax on bank assets.

In Romania there is no tax on bank assets. However, parliament recently proposed a Mortgage Loans Law, which is under revision after being criticized by the National Bank of Romania and by the European Central Bank in December 2015. The rationale behind this law is the following: people who cannot afford to repay their loans can give up their mortgage.

As the Top 10 SEE rankings show, among the 10 biggest banks in the region, five are Romanian: Banca Comerciala Romana, BRD (part of Groupe Societe Generale), Banca Transilvania, Raiffeisen Bank and UniCredit Tiriac Bank. The profitability of the sector in Romania is about 7-8 per cent a year. Is the Romanian banking sector strong?

The Romanian banking sector is currently recovering after the severe adjustment of the Great Recession. 2015 was the first year of a new business cycle in the Romanian banking sector, as reflected by the re-launch of credit markets, the improvement of aggregate results, consolidation of capital adequacy ratios and the decline of non-performing loans. At the same time, the loan-to-deposit ratio declined to a record low level of around 86 per cent in December 2015, contributing to a lower dependence on foreign capital flows. We may state that, at present, the Romanian banking sector is well positioned to face mid-term challenges.

What are the most recent projections for the sector?

We expect the re-launch of the credit markets to gather momentum in the following quarters given increasing demand, supported by the acceleration of private consumption and of fixed investments, but also an improvement in supply. Annual non-government loans dynamics may converge to double digits in 2017-2018. At the same time, we expect the consolidation process to continue and to accelerate in the mid-run, as the pressures increase in terms of revenues/margins and costs —regulation, digital, headcount.

More and more researchers and authors point out that there is no such a phenomenon as “middle income trap”. Robert Barro from Harvard University showed that in the long run switching from a low-income country level to middle-income country level is exactly as hard as switching from middle-income level to high-income level. Longefeng Ye and Peter E. Robertson from Australia claim that there are hardly any countries in a middle-income trap, finding only seven. But they list Romania among them. For how long will Romanians be cut off from the fruits of economic growth?

The Romanian economy was confronted with several shocks since 1989, leading to structural changes:

  1. The transition towards the market economy (1990-2000)
  2. The first market economy business cycle (2001-2008) marked by the integration with the EU (2007)
  3. The Great Recession and the severe and prolonged adjustment (2008/2009-2013), given the high level of the macroeconomic disequilibria accumulated before the crisis (double digit current account deficit, pro-cyclical fiscal and income policies).
  4. The post-crisis economic cycle.

Overall, Romanians managed to address the above mentioned challenges and real economic convergence with the Euro Area improved over time. GDP per capita is above 50 per cent of the Euro Area average and may hit 60 per cent by the end of this decade. Romanians are now seeing economic growth after many years of adjustment, shown by the improvement of real disposable income. This trend should continue in the following years, as the Romanian economy is shining again in terms of potential output and macro-financial stability, is whitening, as the weight of the informal economy decreases, and continues to be cheaper and more flexible compared with its regional peers. At the same time, Romania is a pillar of stability in the current situation of geo-political tension, which is positive for new investments. However, there are important differences among the regions. For instance the capital Bucharest, but also Cluj-Napoca and Timisoara, are highly integrated with West European economies. On the other hand, the regions like Moldova and Oltenia are among the poorest in the EU.

In this context, we point out that the middle-income trap may be avoided by Romania in the mid-term only through implementing structural reforms, namely investing in infrastructure, a proper regional policy in order to reduce disparities, R&D, education, health and development of capital markets.

What more needs to be done to let people benefit from this growth?

At present Romanian economic policy is relaxed and growth supportive. The monetary policy rate is at record low levels — 1.75 per cent — while excess liquidity has pushed money market rates to very low levels — the 3M ROBOR is around 0.8 per cent, 6M ROBOR at 1 per cent. In terms of fiscal policy, the government introduced the New Fiscal Act, with the general VAT cut from 24 per cent to 20 per cent starting January 1st, 2016 — after the VAT was diminished for food and food services from 24 per cent to 9 per cent in June 2015. Last but not least, the government increased public wages at the end of 2015. These measures contributed to the improvement of real disposable incomes, with spillover effects for private consumption — acceleration towards pre-crisis levels.

However, Romanians are more conservative after the crisis and they are also increasing savings: the savings ratio hit 13 per cent in 2015 — close to the EU average — the highest level since the 1990s. In other words, people consume more but also save more and this is good for macro-economic dynamics in the short and mid-run.

Is Romanian Moldova still the poorest region of Romania?

According to the Eurostat Regional Yearbook 2015, Romanian Moldova in the Northeast of Romania is the poorest region in the country, with a GDP/capita of 33.9 per cent of the EU average. This is the fourth least developed region in the EU.

What are the advantages of that region? What could attract investors?

The low level of development in Romanian Moldova is rooted in the post-World War II economic and military order. The region is near the border with the former USSR and the communist regime did not strategically invest there, being afraid of possible conflicts with the Kremlin. In this context, many people from Moldova migrated to other regions in the country. The region is attractive for investments in industry, due to cheap labor, tourism, given the history of the region, and agriculture, given the properties of the soil.

The Internet portal Imobiliare.ro has just announced Romanians have huge appetites for houses, although JLL, the real estate consultancy, reports commercial/non-residential real estate investments halved in 2015. What’s the situation in the real estate and construction sector from an insider’s perspective? Are prices going up after the bursting of the property bubble of 2002-2007?

The real estate market was strongly affected by the first wave of the Great Recession, due to the sudden stop of financing which had an unfavorable impact on demand. The First House Program contributed to the stabilization of the real estate market in Romania — prices increased in 2015, at least according to Eurostat. At present forces seem balanced in the real estate market, as increasing demand is counterbalanced by higher supply — there are many projects under construction, especially in the important cities. In this context, we point out that the final shape of the Mortgage Loans Law would influence demand on real estate markets.

Are mortgages a big part of overall loans in Romania?

Mortgage loans increased significantly in past years, especially due to the First House Program. At the end of 2015 the weight of the mortgage loans in the total non-government loans was 24 per cent. However, the weight of the mortgage loans in total household non-government loans was close to 50 per cent at the end of 2015.

And from the investors’ view, which sectors are now most promising? Energy? IT?

IT&C has been the best performing sector over past quarters. Given the new economic cycle we expect cyclical sectors to present a good performance in the mid-run —construction, retail — while industry would accelerate, on the back of the domestic demand perspectives, in Romania and in the Euro. Last but not least, there is important potential for agriculture.

And the last question, this one about Deutsche Bank. After a series of losses, questions were raised about repaying the coupons of DB’s CoCo bonds in April 2016. German Finance Minister Wolfgang Schauble stated, “We should have no concern over Deutsche Bank”. Do you agree?

The rumors regarding the European banking sector over the past weeks were determined by several factors: the implementation of the European Banking Union project — the transition from bail-out to bail-in; the low level of transparency at the bank level in terms of exposure to the oil and gas sector in a context of declining commodities prices; and increasing pressure in terms of margins given the ECB monetary policy outlook. However, we believe the New Economic Governance in Europe to significantly reinforce the health of the banking sector in the region. In this context, the president of the European Central Bank, Mario Draghi, recently underlined the strengths of the European banking sector and the importance of measures implemented since the incidence of the crisis for the consolidation of this sector. Thus, the rumors regarding Deutsche Bank seem exaggerated.

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