Romania – nominal andreal convergence

on the way to euro adoption

Ionut DumitruPresident of the Fiscal Council and

Chief-economist, Raiffeisen Bank Romania

February 2015

Eurozone enlargement – current status

Source: European Commission

Initial target Date of setting the target Current targetBulgaria 2010 2004 no target dateCroatia 2019 no target dateCzech Republic 2009/2010 2003 no target dateHungary 2008 2003 no target dateLithuania 2007 2004 2015Poland 2008/2009 2003 no target dateRomania 2014 2007 2019Denmark no target not obliged to joinSweden no target de facto opt-outUnited Kingdom no target not obliged to join

I. Nominal convergence.Maastricht criteria

Source: European Commission

Nominal convergence: Maastricht criteria

1. Inflation

“the achievement of a high degree of price stability; a Member State has a price performance that is sustainableand an average rate of inflation, observed over a period of one year before the examination, that does notexceed by more than 1.5 percentage points that of, at most, the three best performing Member States in terms ofprice stability.”

2. Long-term interest rate developments“observed over a period of one year before the examination, a Member State has had an average nominallong-term interest rate that does not exceed by more than two percentage points that of, at most, the three bestperforming Member States in terms of price stability. Interest rates shall be measured on the basis of long-termgovernment bonds or comparable securities”

3. Public budget deficit is below 3.0% of GDP“the sustainability of the government financial position will be apparent from having achieved a governmentbudgetary position without a deficit that is excessive”, i.e. that exceeds 3.0% of GDP on permanent basis

4. The ratio of government debt to GDP is less than 60% of GDP

5. Exchange rate stability under ERM II mechanismMember State has respected the normal fluctuation margins [+/-15%] provided for by the exchange ratemechanism on the European Monetary System without severe tensions for at least the last two years before theexamination

Source: European Commission

Sustainability of public financial position

Note: European Commission (Feb 2015)

0

10

20

30

40

50

60

70

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

F

20

15

F

20

16

F

Gross public debt (% of GDP)

Romania's EUaccession >>>

Maastricht criteria: 60% of GDP

-10

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

F

20

15

F

20

16

F

Public budget balance (% of GDP)

Romania's EUaccession >>>

Maastricht criteria: -3.0% of GDP

2009-2013: EDP in place

Source: European Commission, European Central Bank

Inflation and long-term interest rates

Note: Reference values for December 2014 (1.3% for inflation and 4.8% for 10Y LCY yields) were computed as averages for Spain, Portugal and Slovakia.Similar to the assessment performed by the ECB in April 2014, there were excluded from computations Greece, Bulgaria and Cyprus.

0

2

4

6

8

10

12

14

Dec

-04

Dec

-05

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13

Dec

-14

Assesment of Maastricht Criteria on inflation

Maastricht reference criteria as computed by the ECB/ECMaastricht reference criteria - own estimatesAnnual inflation rate in Romania (% yoy, average 12-months)

0

2

4

6

8

10

Dec

-04

Dec

-05

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13

Dec

-14

Assesment of Maastricht Criteria on interestrates (10-year LCY yields)

10-year yield on RON T-bonds (%, average last 12 months)

Maastricht reference criteria as computed by the ECB/EC

Maastricht reference criteria - own estimates

Source: Eurostat

Achieving the inflation criterion is a difficult task

3.6

3.0

2.7 2.6

2.3 2.32.1

1.9 1.9 1.9

RO EE HU UK FI AT LT MT LU PL

Average annual inflation rate (from Dec2009 to Dec 2014) - 10 largest advances

EU 28 average = 1.8%

4651 52

5660

63 65 65 67

73

Bu

lga

ria

Ro

ma

nia

Po

lan

d

Hu

ng

ary

Lith

ua

nia

Cro

ati

a

Cze

ch R

ep.

Slo

vak

ia

Latv

ia

Esto

nia

Level of consumer prices in 2013(% of Euro area 15), 10 lowest levels

Note: level of consumer prices is computed based on household finalconsumption expenditure

II. Real convergence

Public policies make a difference

Source: European Commission

29.1

24.5

39.2

30.6

59.9

41.7

45.8

59.0

28.2

21.7

48.3

20

25

30

35

40

45

50

55

60

65

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

GDP per capita in PPS(% of average for Germany and France)

Bulgaria Poland Hungary Romania

Note: Estimates for the year 2014

Real convergence: not a one way street

Source: European Commission

50

60

70

80

90

100

110

120

130

140

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

GDP per capita in PPS(% of average for Germany and France)

Italy Ireland Portugal Spain Greece

Euro area enlargement: euro adoptedrecently only by small countries

Source: European Commission, Eurostat

0

2

4

6

8

10

12

14

Ma

lta

Cy

pru

s

Esto

nia

Latv

ia

Slo

ven

ia

Slo

vak

ia

Ro

ma

nia

Lith

ua

nia

Bu

lga

ria

Hu

ng

ary

Cze

ch R

epu

blic

Po

lan

d

Po

rtu

ga

l

Gre

ece

Spa

in

Stable population in 2013 (% of Euro area)

Gross domestic Product in 2013 (% of Euro area)

Euro adoption years:

2007: Slovenia

2008: Malta, Cyprus

2009: Slovakia

2011: Estonia

2014: Latvia

2015: Lithuania

Euro area enlargement: deep foreign tradeintegration for Euro area late comers

Source: European Commission, Eurostat, Raiffeisen RESEARCH

0

20

40

60

80

100

120

Spa

in

Po

rtu

ga

l

Gre

ece

Slo

ven

ia

Cy

pru

s

Ma

lta

Slo

vak

ia

Esto

nia

Latv

ia

Ro

ma

nia

Lith

ua

nia

Bu

lga

ria

Hu

ng

ary

Cze

ch R

epu

blic

Po

lan

d

1999 2001 2007 2008 2008 2009 2011 2013 2013 2013

Exports of goods and services (% of GDP)

Exports towards EU member countries (% of GDP)* Exports towards non EU member countries (% of GDP)*

Total exports of goods and services in 2013 (% of GDP)

* computed in the year of Euro adoption for new Euro area member countries and in 2013 for non Euro area member countries

Euro area enlargement: high GDP per capitaat the moment of euro adoption

Source: Eurostat, Raiffeisen RESEARCH

81

6775 78

89

7264

59 57 58

Spa

in

Po

rtu

ga

l

Gre

ece

Slo

ven

ia

Cy

pru

s

Ma

lta

Slo

vak

ia

Esto

nia

Latv

ia

Lith

ua

nia

1999 2001 2007 2008 2008 2009 2011 2014 2015

GDP per capita in PPS as % of Germany+Francein the year of accession in Euro area

Real convergence in Romania by 2019:some scenarios

Source: European Commission, Eurostat, own computation

Real GDP should grow by at least 4% onaverage per year to be in Scenario 2.

Reference period Romania Germany+France2001-2008 12.2 3.02001-2014 8.3 2.32006-2014 7.3 2.02009-2014 3.2 1.32011-2014 4.6 2.0

Scenarios for period 2015-2019

GDP per capita inRomania in 2019 (% of

Germany and France)

Scenario 1 4.5 2.0 55Scenario 2 6.0 2.0 59Scenario 3 7.0 2.0 61

GDP per capita at PPS (%yoy, average for period)

48 55

5961

20

30

40

50

60

70

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

GDP per capita at PPS in Romania(% of Germany+France)

Scenario 1: +3.0% pe year growth in GDP per capita at PPS

Scenario 2: +4.5% pe year growth in GDP per capita at PPS

Scenario 3: +6.0% pe year growth in GDP per capita at PPS

III. Recent economic growthdevelopments

A booming economy before the crisis

Source: Eurostat

BG

CZ

EE

LVLT

HU

PL

RO

SI

SKHR

2

3

4

5

6

7

8

9

10

2 4 6 8 10

An

nu

al g

row

th r

ate

fo

r d

om

esti

c d

ema

nd

(ave

rag

e 2

00

1-2

00

8)

Annual growth rate for real GDP (average2001-2008)

GDP growth drivenby domesticdemand

GDP growth drivenby exports

1.82.1

3.3

4.04.3 4.3

5.76.0 6.2

6.5

7.4 7.5

EA

EU 2

7

HU PL

HR

CZ

BG EE SK RO LV LT

Annual average GDP growth(2001-2008)

Scarce net inflows of foreign capital toprivate sector, slow recovery pace

Source: National Bank of Romania, National Institute of Statistics

Note: net inflows of foreign capital in the private sector; portfolio inflows excluded

-9

-6

-3

0

3

6

9

12

02

Q4

03

Q4

04

Q4

05

Q4

06

Q4

07

Q4

08

Q4

09

Q4

10

Q4

11

Q4

12

Q4

13

Q4

14

Q4

e

Real GDP excluding agriculture (% yoy)

7.8% per year

2.6% per year

-10

-5

0

5

10

15

20

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

Net FDIs (% of GDP)

Net loans, deposits (% of GDP)

Total inflows of foreign capital in private sector (% of GDP)

Less room to use indebtedness to leverageeconomic growth

Source: European Commission, Eurostat, Raiffeisen RESEARCH

0

10

20

30

40

50

60

70

80

20

00

20

01

20

02

20

03

20

04

20

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20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

e

GDP per capita at PPS in Romania (% of Germany+France)Gross external debt (% of GDP)Gross public debt (% of GDP)

Pre-crisis imbalances had to be adjusted

Source: Eurostat, National Bank of Romania, European Commission,

-16

-14

-12

-10

-8

-6

-4

-2

0

2

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

F

Foreign trade balance, goods&services (% of GDP)

Current account balance (% of GDP)

-10

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

F

Public budget balance (ESA 2010, % of GDP)

Structural public budget balance (% of GDP)

Sharp contraction in domestic demandfollowed by a modest recovery

Source: National Institute of Statistics, Raiffeisen RESEARCH

60

70

80

90

100

110

120

130

140

150

20

08

20

09

20

10

20

11

20

12

20

13

20

14

e

GDP and demand (2008=100)

Private consumption

Gross fixedcapital formation

GDP excludingagriculture

Exports

Signs of revival in households spending

Source: National Institute of Statisitcs, European Commission, RaiffeisenRESEARCH

Note: normalized levels (deviation from meanrelative to standard deviation); 3-month movingaverages

Note: 3-months moving averages

90

100

110

120

130

Dec

-14

Dec

-13

Dec

-12

Dec

-11

Dec

-10

Dec

-09

Dec

-08

Retail sales(deflated turnover, 2010=100)

Non-foods, excluding fuels Foods

Fuels Total retail sales

-3

-2

-1

0

1

2

3

Jan

-15

Jan

-14

Jan

-13

Jan

-12

Jan

-11

Jan

-10

Jan

-09

Jan

-08

Jan

-07

Jan

-06

Jan

-05

Consumer confidence index

Euro area CEE 4 countries Romania

Increasing volatility on the external markets

Source: Bloomberg, Raiffeisen RESEARCH

10

12

14

16

18

20

22

24

Feb

-13

Ap

r-1

3

Jul-

13

Sep

-13

No

v-1

3

Jan

-14

Ma

r-1

4

Ma

y-1

4

Jul-

14

Sep

-14

Dec

-14

Feb

-15

VIX index

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Feb

-14

Ap

r-1

4

Ma

y-1

4

Jul-

14

Au

g-1

4

Oct

-14

No

v-1

4

Jan

-15

Feb

-15

Yields for US and German T-securities

US 5Y US 10YGermany 5Y Germany 10Y

Deleveraging under way

Source: National Bank of Romania, Raiffeisen RESEARCH

0%

5%

10%

15%

20%

25%

30%

35%

40%

04Q4 06Q4 08Q4 10Q4 12Q4 14Q4e

Gross external debt, by sectors

Central bank and government (% of GDP)Banking system (% of GDP)Private non-banking sector (% of GDP)

0

5

10

15

20

25

04Q4 06Q4 08Q4 10Q4 12Q4 14Q4e

Stock of banking loans, by sectors

Consumer loans (% of GDP)Housing loans (% of GDP)Banking loans for individuals (% of GDP)Banking loans for companies (% of GDP)

GDP growth in 2015 to be supported by: Improving activity on external markets Lower constrains stemming from the fiscal side Further progress in absorption of EU funds Low levels of RON and EUR lending rates Lower risk premium as a result of low

macroeconomic imbalances

Main risks and challenges Risks stemming from politics have reduced but

uncertainty on policies has preserved - increasingrisks for fiscal slippages

Potential increase in risk aversion of investorstowards EM assets

A bad agricultural year (increase in inflation rate,ROBOR rates and RON yields, lower GDPdynamics)

Better prospects for GDP growth, buthigher growth is strongly needed

Source: National Institute of Statistics, Raiffeisen RESEARCH

-8

-6

-4

-2

0

2

4

6

8

10

12

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

E

20

15

E

20

16

E

Real GDP excluding agriculture (% yoy)

Low level of competitiveness

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

Note: Red lines denote scores for Romania

World Economic Forum World Competitiveness Report – Ranking(out of 144 countries)

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

Romania Bulgaria Czech Republic Hungary Poland Slovak Republic 7.05 Effect of taxation on incentives to work, 1-7 (best) 140 91 110 128 88 119 6.04 Effect of taxation on incentives to invest, 1-7 (best) 128 81 107 133 102 114 7.08 Country capacity to retain talent, 1-7 (best) 128 142 80 122 117 130 7.07 Reliance on professional management, 1-7 (best) 126 113 47 114 71 74 7.01 Cooperation in labor-employer relations, 1-7 (best) 125 111 52 71 100 105 2.02 Quality of roads, 1-7 (best) 121 106 81 58 89 82 6.01 Intensity of local competition, 1-7 (best) 120 75 17 47 51 32 6.09 Prevalence of trade barriers, 1-7 (best) 117 99 72 30 66 38 1.08 Wastefulness of government spending, 1-7 (best) 116 98 7 96 85 126 7.09 Country capacity to attract talent, 1-7 (best) 115 142 93 118 124 117 1.07 Favoritism in decisions of government officials, 1-7 (best) 114 134 106 122 67 141 4.10 Primary education enrollment, net %* 114 66 55 95 49 n/a 1.17 Ethical behavior of firms, 1-7 (best) 112 101 94 96 57 123 1. Corporate ethics 112 101 94 96 57 123

…. 5.06 Internet access in schools, 1-7 (best) 53 45 27 35 50 31 2.09 Fixed telephone lines/100 pop.* 52 42 63 37 78 68 9.03 FDI and technology transfer, 1-7 (best) 49 91 36 19 68 18 6.07 No. days to start a business* 48 84 92 14 111 87 1.21 Strength of investor protection, 0–10 (best)* 45 45 83 105 45 98 10.01 Domestic market size index, 1–7 (best)* 44 66 48 56 20 61 9.05 Fixed broadband Internet subscriptions/100 pop.* 40 39 41 31 46 47 6.06 No. procedures to start a business* 32 22 106 22 22 78 5.04 Quality of math and science education, 1-7 (best) 31 54 74 60 50 75 9.06 Int’l Internet bandwidth, kb/s per user* 19 27 25 75 37 93 8.08 Legal rights index, 0–10 (best)* 11 11 63 43 11 29 7.04 Redundancy costs, weeks of salary* 7 21 95 61 89 89

WOR

STBE

ST

World Bank Doing Business Report – Ranking (out of 189 countries)

Source: World Bank Doing Business 2015 Report

Starting aBusiness

Registering Property

GettingCredit

ProtectingMinorityInvestors

TradingAcross

Borders

EnforcingContracts

Rank RankTime

(days)Rank

Time(days)

Cost (%of

incomeper

capita)

Rank Rank Rank RankPayments(numberper year)

Time(hours per

year)

Total taxrate (%profit)

Rank Rank RankTime

(years)

Recoveryrate

(cents onthe dollar)

United States 7 46 41 78.6 61 89.6 25.5 29 2 25 47 10.6 175 43.8 16 41 4 1.5 80.4Germany 14 114 8 96 3 28 44.4 89 23 51 68 9 218 48.8 18 13 3 1.2 83.4Poland 32 85 137 212 64 161 20.8 39 17 35 87 18 286 38.7 41 52 32 3 57Slovak Republic 37 77 110 286 100 128 56.9 11 36 100 100 20 207 48.6 71 55 31 4 54.4Bulgaria 38 49 101 110 125 130 320.4 57 23 14 89 13 454 27 57 75 38 3.3 33.2Czech Republic 44 110 139 143 123 129 175.8 31 23 83 119 8 413 48.5 58 37 20 2.1 65.6Romania 48 38 140 255 171 223 496.1 63 7 40 52 14 159 43.2 65 51 46 3.3 30.7Slovenia 51 15 90 212.5 31 38 119.3 90 116 14 42 11 260 32 53 122 42 2 50.1Hungary 54 57 103 91 162 252 111.5 52 17 110 88 11 277 48 72 20 64 2 40.2

Resolving InsolvencyPaying Taxes

Economy

Ease ofDoing

BusinessRank

Dealing withConstruction

PermitsGetting Electricity

World Bank Doing Business Report – Paying taxes, ranking (out of189 countries)

Source: World Bank Doing Business 2015 Report

Economy Rank Payments (number per year) Time (hours per year) Profit tax (%) Labor tax and contributions (%) Other taxes (%) Total tax rate (% profit)Ireland 6 9 80 12.4 12.1 1.4 25.9Denmark 12 10 130 20.3 3 2.8 26Bulgaria 89 13 454 5 20.2 1.7 27Switzerland 18 19 63 9.5 17.7 1.8 29Slovenia 42 11 260 12.5 18.2 1.4 32United Kingdom 16 8 110 20.9 11.3 1.5 33.7Europe & Central Asia .. 20.5 234.3 10.4 21.4 3.1 34.9Poland 87 18 286 13.1 24.7 1 38.7Netherlands 23 9 123 21.1 17.6 0.4 39Norway 15 4 83 24.8 15.9 0 40.7OECD high income .. 11.8 175.4 16.4 23 1.9 41.3Portugal 64 8 275 15.1 26.8 0.5 42.4Romania 52 14 159 10.7 31.5 1 43.2United States 47 10.6 175 28.2 9.7 6 43.8Hungary 88 11 277 11.8 34.3 1.8 48Czech Republic 119 8 413 7.6 38.4 2.6 48.5Slovak Republic 100 20 207 8.5 39.7 0.4 48.6Germany 68 9 218 23.3 21.2 4.3 48.8

Source: National Institute of Statistics, Raiffeisen RESEARCH.

Economic activity concentrated in a small number of counties

TR

B

GRCL

DJ

IF

CT

IL

OT

MH

GJ DB

PH BR TLVL AGCS

BZ

BV GLVNTMSB CV

HD

AB

ARBC

VSMS HR

NTCJ

SJ BN IS

BH

SVMMSM

BT

Nominal GDP per capita (2011, % of country average)

<= 50%

(50%, 75%]

(75%, 100%]

(100%, 125%]

(125%, 150%]

> 150%

Only 5 counties produce more than 40% of GDP.

Source: Ministry of Finance, Raiffeisen RESEARCH.

Large companies are concentrated even more

Over 50% of large companies are located in 5 counties.

TR

B

GRCL

DJ

IF

CT

IL

OT

MH

GJ DB

PH BR TLVL AGCS

BZ

BV GLVNTMSB CV

HD

AB

ARBC

VSMS HR

NTCJ

SJ BN IS

BH

SVMMSM

BT

Number of companies with net turnover above EUR 5 mn. (2012)

<= 50

(50, 100]

(100, 150]

(150, 200]

(200, 250]

> 250