Romania Diagnostic Jakov Milatovic and Mateusz Szczurek January 2020 This report was prepared by Jakov Milatovic, Principal Economist at the Economics, Policy and Governance (EPG) department at the EBRD, under the supervision of Mateusz Szczurek, the Lead Regional Economist, and analytical support of Dan Meshulam, intern at EPG. Important contributions to the analysis were made by Dimitris Sourvanos and Oleg Levitin on political economy and governance, Kjetil Tvedt on the state of transport and municipal infrastructure, Dejan Vasiljev on access to finance, Marko Stermsek and Elias Habbar-Baylac on labour market, gender and inclusion issues, Giorgio Manenti on knowledge economy, and Philipp Paetzold on value chains analysis. We are grateful for guidance and comments provided by Mattia Romani (Managing Director, EPG), Artur Radziwill (Director, Country Economics and Policy) and Peter Sanfey (Deputy Director, Country Economics and Policy). We are also grateful to numerous other colleagues in EPG for helpful contributions. The report has benefited from comments from EBRD colleagues in other departments, including Banking, Office of the Chief Economist, Office of the General Counsel, Country Strategy and Results Management, Energy Efficiency and Climate Change. The views expressed in this paper are those of the authors only and not necessarily those of the EBRD. The report is based on latest available data. Country diagnostics are an EBRD tool to identify the main obstacles to entrepreneurship and private sector development and to help shape the Bank’s strategic priorities and project selection in new country strategies. Each diagnostic informs the EBRD’s policy engagement with the authorities in the country. Each country diagnostic assesses the progress and challenges of the country of operations in developing a sustainable market economy. Private sector development and entrepreneurship are at the heart of the Bank’s mandate in the regions of operation of the bank, but the private sector in all EBRD countries faces a range of problems and obstacles. The diagnostic highlights the key challenges facing private companies and shows where each country stands vis-à-vis its peers in terms of six qualities of transition – competitive, well- governed, resilient, integrated, green, and inclusive – and points out the main deficiencies and gaps in each quality. The diagnostics draw on a range of methodologies and best practice for assessing how big different obstacles are. Extensive use is made of in-house expertise across the EBRD, along with surveys such as the Business Environment and Enterprise Performance Survey (BEEPS) and the Life in Transition Survey (LiTS), as well as other cross-country surveys and reports from institutions such as the World Bank, World Economic Forum and OECD. For some larger countries, the diagnostics also draw on specially commissioned studies of selected issues that are critical for private sector development in the country. The diagnostics are led by the EBRD’s Country Economics and Policy team, drawing substantially on the expertise of sector, governance and political experts in the Economics, Policy and Governance department (EPG) and consulting widely with relevant experts across the EBRD when preparing the final product. The diagnostics are shared with the EBRD Board during the country strategy process and published during the public consultation period. The views expressed in the diagnostic papers are those of the authors only and not of the EBRD. For more information, go to: https://www.ebrd.com/publications/country-diagnostics Romania Diagnostic January 2020 This report was prepared by Jakov Milatovic, Principal Economist at the Economics, Policy and Governance (EPG) department at the EBRD, under the supervision of Mateusz Szczurek, the Lead Regional Economist, and analytical support of Dan Meshulam, intern at EPG. Important contributions to the analysis were made by Dimitris Sourvanos and Oleg Levitin on political economy and governance, Kjetil Tvedt on the state of transport and municipal infrastructure, Dejan Vasiljev on access to finance, Marko Stermsek and Elias Habbar-Baylac on labour market, gender and inclusion issues, Giorgio Manenti on knowledge economy, and Philipp Paetzold on value chains analysis. We are grateful for guidance and comments provided by Mattia Romani (Managing Director, EPG), Artur Radziwill (Director, Country Economics and Policy) and Peter Sanfey (Deputy Director, Country Economics and Policy). We are also grateful to numerous other colleagues in EPG for helpful contributions. The report has benefited from comments from EBRD colleagues in other departments, including Banking, Office of the Chief Economist, Office of the General Counsel, Country Strategy and Results Management, Energy Efficiency and Climate Change. The views expressed in this paper are those of the authors only and not necessarily those of the EBRD. The report is based on latest available data. Executive summary Romanian economy has been developing fast. The country benefitted considerably from the European Union (EU) membership. GDP per capita, adjusted for purchasing power standards, has converged from 43 per cent of the EU average in 2007 (the year of entry) to about 65 per cent today. Yet the journey towards an advanced market economy, which is sustainable, well-governed and inclusive, remains far from complete. This study highlights the key transition challenges and shows where Romania stands vis-à-vis its peers. Key obstacles to private sector development in Romania identified in this paper are the following: • Unpredictable business environment, hindered by weak institutions, defers investment • Low credit intermediation and limited alternative sources of finance limit transition to private sector-led knowledge economy • Large regional disparities create obstacles for competitiveness and welfare of the country as a whole • Labour and skills shortages threaten the potential growth prospects • The poor state of transport and municipal infrastructure exacerbates regional disparities and limits value chain/market integration To better understand those key obstacles, the diagnostic study provides a short political and economic overview. The diagnostic exercise presented in the paper finishes with the short description of each of the six desirable qualities of a sustainable market economy, as per adopted EBRD methodology for measuring transition, namely: competitive, well- governed, green, inclusive, resilient, and integrated. Romania Diagnostic January 2020 │ 5 1. Political and Economic overview 1.1 Political economy 1.2 Convergence potential Romania’s transition to democracy and market Romanian economy is developing fast; economy, following the collapse of the communist nevertheless, the country has still some way to go regime, unfolded at a slower pace than in some towards a sustainable market economy. Current other countries in the region. Since the second GDP per capita, adjusted for purchasing power decade of the transition, Romania’s political system standards, is at about 65 per cent of EU average. has been characterised by the polarisation between the centre-left and centre-right camp. Romania is a Romania’s real output is today 1.7x higher than in semi-presidential republic often experiencing difficult 1989 (Chart 1). Economic development of Romania cohabitation between the President and the since the fall of the Berlin Wall can be divided into government, especially when they come from the two four distinct phases: early transition, boom, bust and opposing political camps. recovery1. The first phase lasted throughout most of the 1990s, and was characterised by a significant Important developments in late-2019 have fall of output (cumulatively of more than 20 per cent changed the political landscape of previous years. of the 1989 levels). During the second phase, which The centre-left PSD, which was elected in December lasted from 2000 through the onset of the global 2016, was ousted from power in October 2019, after financial crisis, economy experienced a dynamic losing its majority in the bicameral parliament a few growth, of almost 7 per cent on average. In 2004, the weeks earlier. A minority government led by the country has reached its 1989 economic output in centre-right PNL of PM Ludovic Orban was invested in real terms. The economic revival was stopped by a November 2019. The new government is supported steep recession in 2009 and 2010, with its by centre-right President Klaus Iohannis, who was re- aftermath of marginal growth. The economy returned elected for another five year term, in late-November to a more dynamic growth rates, above 3 per cent, in 2019. The political environment is expected to 2013. remain relatively volatile ahead of the next general elections in late-2020. Chart 1: Cumulative real economic growth, 1989 (real) GDP level = 100 There is considerable amount of consensus in the country regarding key foreign policy priorities. However policy making has suffered from a lack of 270 250 Poland consistency and the adverse impact on public 230 administration of the political infighting in top 210 Romania echelons. In addition, the short lifespan of 190 Hungary governments and the numerous changes in 170 Bulgaria 150 100 ministries have adversely affected continuity in 130 policies. 110 Index: 100=1989 GDP level 90 Romania joined NATO in 2004 and the EU in 2007. 70 50 Support for both NATO and the EU memberships have been relatively high. Romania held its first (six- 1989