2. ECONOMIC TRENDS AND OUTLOOK

Major Trends and Outlook

Romania has made a slow and painful transition towards a market economy since its revolution in 1989. This transition was made more difficult by the legacy of the communist regime: centralization, a high degree of bureaucracy, and lack of experience in partial reform measures undertaken in other Central European economies during the 1980s. Despite this history, Romania's economy has recently displayed rapid growth and booming consumer and light manufacturing sectors that, if the trend continues, bode well for future investments.

The successive governments that ruled the country between December 1989 and November 2000 avoided serious economic reform, fearing "shock therapy" and its anticipated social costs. Reform packages to establish clear restructuring and privatization procedures, eliminate subsidies, establish a more efficient banking system, introduce a modern tax system, and encourage foreign investment all failed, largely due to lack of commitment and follow-through. Lenient government attitudes toward the accumulation of arrears by state-owned enterprises, coupled with inefficient bankruptcy procedures, indirectly subsidized unprofitable behavior, while good corporate governance was undermined by vested interests. An unpredictable investment climate, together with lack of labor mobility, a weak tax base, and high inflation, inhibited private sector growth.

In spite of these difficulties, and after years of decline, Romania's economy started an upward trend in 2000. GDP grew 1.8% in 2000, and 5.3% in 2001. From 2000 to 2001, industrial output increased by 7.9%. The dynamic growth was registered in manufacturing, up 9.6%, and the mining sector, up 4.9%. The highest increases were posted in sectors with significant export markets: machines and equipment (+17.9%), electric machines (+11.6%), and clothing apparel (+ 6.7%). Only the production of durable consumer goods decreased slightly. A 21.2% increase in agricultural production in 2001 also contributed to the steep rise in GDP. During the first three months of 2002, the positive trend in industrial production has continued.

Moody's, Fitch, and Standard and Poor have all recently gradually upgraded Romania's credit ratings.

Principal Growth Sectors

Information and Communication Technology - The ICT sector is probably the most dynamic component of Romania's economy, and one that is receiving priority attention from the government. Over the last ten years, the sector has experienced impressive development, offering Romania the latest technologies in most sub-sectors. This will enable the country to make the transition to 3G communications at a fast pace.

At the end of 2001, Romania became the first country to deploy CDMA 2000 in Europe and the first in the world to build a high-speed (153 kbs) mobile digital 450 MHz network using the CDMA technology. The next three years will see the further development of broadband applications, as well as of such data transmission technologies as Terrestrial Trunked Radio and General Packet Radio Service (to become predominant at the end of 2003). UMTS/3G technology is expected to be commercially available by the end of 2003. By the end of 2002, the Ministry of Communications and IT will grant four UMTS/3G licenses. These will not be put up for sale, but granted according to the criterion of service quality.

Projects for the upgrading of all types of infrastructure, allowing an increase in Internet penetration, will also be strongly encouraged. The growth of the sector will be closely linked to the full deregulation of the telecommunications market, scheduled to occur on January 1, 2003. There will be no limit to the number of new licenses for wired telephony, which will be granted at no cost, based solely on the quality of the services to be provided.

The rapid growth of the ICT sector will be also sustained by the strength of Romania's large pool of highly skilled labor in engineering and electronics manufacturing, as well as by its high number of software developers. A large number of pilot projects related to the development of e-market and to the implementation of e-government (e-procurement, e-tax, e-invoice, e-referendum, info-kiosk, etc.) are underway and are being implemented at the national level as the needed infrastructure becomes available. Investment associated with the implementation of all of the above-mentioned projects will amount to several billion dollars in the near term.

Power Generation - In 2001, Romania produced 53,866 GWh electricity, of which 31,418 GWh was produced by thermal power plants, 14,626 GWh by hydropower plants, and 5,446 GWh by the Cernavoda nuclear plant. The Romanian government plans to increase power output by upgrading existing facilities. Total investment over the next 10 years will amount to $12-15 billion. The investments will target the completion of the second unit of Cernavoda nuclear plant ($350 million), the completion of 21 hydropower plants ($1 billion), privatization of electricity distribution ($1 billion), and the rehabilitation of thermal power plants.

Oil and Gas - Petrom, the National Oil Company, is active in all aspects of the oil and gas industry, from the exploration and production of crude oil and natural gas to the refining, distribution and transportation of refined petroleum products and natural gas. The Ministry of Industry and Resources has started Petrom's privatization, which, according to the IMF's stand-by agreement with Romania, will be completed by early 2003. Petrom's privatization is closely monitored by international financial institutions. EBRD signed a $150 million credit for Petrom's restructuring, which will increase the market value of the company, and has expressed interest in acquiring up to 5% of Petrom.

Privatization of the natural gas distribution companies Distrigaz Nord and Distrigaz Sud, which will put an end to the state monopoly on gas distribution, is expected to begin in July-August 2002 and to be completed in two years. The value of the transaction is estimated at several hundred million dollars.

The U.S. Trade and Development Agency is funding a feasibility study for the construction of a pipeline to transport Caspian oil from the Romanian port of Constanta across Serbia and Croatia to Trieste, Italy.

Transportation - The Ministry of Public Works, Transportation and Housing has established a broad plan to achieve the necessary rehabilitation and modernization of the Romanian road and rail infrastructure, to be implemented in the next five to ten years. Many aspects of the plan are directly related to international loans received by Romania. The Ministry is focused on expending the funding provided by the World Bank, EBRD and other lending institutions for the rehabilitation, modernization and expansion of the existing transportation infrastructure. The objectives for the next ten years include the rehabilitation of national roads to European class roads, construction of motorways, rehabilitation of major rail routes on Pan European Corridors and modernization of freight and passenger cars.

Agribusiness - With 15 million hectares of agricultural land, and excellent conditions for a wide variety of crops, as well as for animal production, farming can be a source of substantial wealth for Romania. Currently, 90 percent of the agricultural land is in private hands. Of the 739 state farms, 214 have been privatized, 34 are in different stages of privatization, and 98 privatization announcements have been posted.

In spite of receiving more attention during recent years, the sector still faces severe problems. Lack of modern technologies, poor quality of equipment, and limited access to credits continue to afflict the Romanian farmer. Special World Bank and EU programs (rural development, agricultural research, SAPARD, etc.) will be implemented to address some of these problems.

The EU accession process requires Romania to open negotiations on agriculture by the end of 2002. This is expected to lead to progress in improving agricultural efficiency and to create a new platform for business opportunities in this sector.

U.S. biotechnology seed products have a notable presence in the Romanian market. Unique in Europe, Romania has pioneered the planting of biotech crops, especially soybeans. Herbicide resistant varieties are currently planted on approximately half of the total area under soybean cultivation. A biotech variety of potato is also approved for marketing, and several biotech corn and sugarbeet products are approved for testing.

The food-processing industry has seen dynamic growth. It was one of the first sectors to be tapped by foreign companies, which formed a large number of joint ventures with local Romanian enterprises. As the Romanian market for food products becomes more sophisticated and demanding, foreign investment in agribusiness will play a greater role.

Real Estate Development - Since the mid-1990s, the sector has been booming. Impressive growth occurred in the construction of stand-alone houses, especially in residential areas of large cities or in tourist resorts, for the use of the country's newly affluent. Modern office buildings, including class A office space, have also proliferated, especially in Bucharest and a few other large cities. Although currently this market segment is saturated, with tens of thousands of square meters of office space vacant, investment in well-located office projects will continue, in anticipation of further business growth and eventual European Union membership. Buying land and building headquarters, warehouses, and large stores on the outskirts of Bucharest and other cities is also a promising trend. Many developers have taken advantage of the privatization process to buy, at very low prices, large, well-located idle industrial facilities for potential industrial, retail or warehousing development. This type of investment has the best potential in the real estate sector for the next several years. Probably the most important segment of the market, which is still in an incipient stage, will be urban developments to be built for middle-income families, with the support of the government, under the provisions of the mortgage law. Almost all municipalities have drawn plans for such developments, and foreign investors are welcome to compete for their construction.

Services - Although the services sector has undergone rapid change since 1990, it remains far below western standards. As the Romanian economy develops, and especially in view of the changes that will be brought about by the information society, the following services are expected to register the fastest growth: banking, insurance, accounting, auditing, legal and financial consulting, advertising and media development. The development of the tourist industry will generate an increase in the market for hotel and restaurant services and leisure activities. Several large western companies specializing in consulting, legal services, accounting, auditing, and advertising already offer their services in Romania.

Government Role in the Economy
While nearly 70% of GDP is generated by the private sector, the government, through the Ministry of Privatization, Ministry of Industry, and others, still owns 65% of Romania's industrial assets. These assets are primarily in the utilities and energy sectors but extend to areas such as movie theaters, chemical plants, transportation, and the metals industry.

Completing the transfer of ownership of assets from the GOR to private hands remains the GOR's biggest and most pressing challenge. There has been little change in the pattern of state-owned enterprises accumulating excessive inter-company and budgetary arrears. Social considerations have often prevailed over economic reasoning, resulting in government granting debt rescheduling or forgiveness to highly indebted state companies. Large loss-makers have also enjoyed sovereign guarantees and piecemeal deals including custom duty and VAT exemptions for imported equipment.

A new EU-inspired law on state aid came into effect in January 2000, designed to regulate and control state aid in any form (as either direct state subsidies, debt rescheduling schemes, or discount prices). However, implementation has been slow and preferential debt rescheduling by the Ministry of Finance and the Ministry of Labor has resulted in major distortions in the market. Furthermore, state aid schemes continue to be non-transparent.

When restructuring and privatization are completed and the basic elements of a market economy are in place, the government's role in the economy will diminish. In the meantime, the government plays a role in the economy greater than in many Western democracies.

Balance of Payments Situation

Romania's current account deficit worsened in 2001, climbing sharply from a $1.4 billion deficit in 2000 to $2.3 billion. This growth was primarily due to a widening trade gap as imports grew twice as quickly as exports. Current account deficits are financed largely via loans and grants from international financial institutions (IFIs) and bilateral donors.

At the end of March 2002, Romania's medium- and long-term external debt amounted to $11.6 billion, while short-term debt totaled $436.0 million. Romania's principal IFI creditors are the World Bank ($2,039.0 million), the EBRD ($795.4 million), the IMF ($365.7 million) and the EU ($196.0 million). Foreign government creditors include Germany ($218.8 million), Canada ($145.6 million), the United States ($99.5 million), and Italy ($40.4 million). U.S. credits consist mostly of loans granted by USDA (mostly from the GSM Program) and loans through the U.S.
Eximbank.

As of March 31, 2002, the National Bank's foreign currency reserves stood at $4.1 billion of a total $5.1 billion including gold. Commercial banks' reserves are an additional $1.4 billion. Romania registered $342.2 million in short-term commercial claims against foreign countries, and still reports claims valued at $3.0 billion from transactions prior to the December 1989 revolution.

Infrastructure

Transportation - Due to its strategic location at the crossroads of Europe and Asia, Romania has the potential to become one of the busiest transport areas in Central and Southern Europe. Improving the condition of the country's road network, restructuring railways, and upgrading the seaport of Constanta are imperative.

Roads

Romania has a network of public roads totaling 198,589 kilometers, of which 14,696 km are national roads which carry 65% of the total road traffic, 36,010 km are county roads, and the rest local roads. Only 114 kilometers are motorways. This is an inadequate road network under current conditions, as total traffic on main Romanian roads has grown eight times over the last 10 years. To improve the condition of the road network, Romania has obtained loans from multilateral lending institutions for the following major projects in this sector:

• First two phases of the national road rehabilitation program ($692 million). The project provides for the rehabilitation of 1,725 km of national roads, is funded by the World Bank, EBRD, and the European Investment Bank (EIB) and is almost completed;

• The third phase of the road rehabilitation program ($364.75 million) provides rehabilitation of 550.33 km of national roads and is funded by the EIB, PHARE, Japanese Bank for International Cooperation (JBIC) and the Romanian Government;


• Border-crossing upgrading ($10.5 million funded by EU-PHARE). Six main border-crossing points are already modernized to ensure adequate flow of international road traffic;
• Road safety ($14.2 million). This includes signing and marking of about 5,000 km of roads designated as European;
• Rehabilitation of Bucharest-Pitesti motorway (96 km, $90 million).

GOR objectives for the next ten years include: the complete rehabilitation of 5,600 km of national roads to European class roads, with funding supplied through international loans coupled with foreign grants and local funding; the modernization of another 1,550 km of national roads (valued at $4.3 billion) with government and municipalities funding; and the resumption of the motorway building program (valued at $5.5 billion). The new motorways will total 900 km, and will cover sections of Pan-European Corridor IV (which crosses Romania from its Western border to the port of Constanta in the East) and of Pan-European Corridor IX (which crosses Romania from North to South, connecting the Republic of Moldova and Bulgaria). The Romanian Government supports the redesign of these two corridors.

Railways

Romanian railways rank seventh in Europe in freight tonnage with about 18 million kilometer - tons transported yearly. The Romanian National Railway Company (SNCFR) maintains 22,219 km of rail tracks, 1,050 railway stations and halts, and 2,332 locomotives, cars and wagons.

Part of Romania's railway strategy for 2001-2010 is the modernization of railway infrastructure, including:

The Romanian railways offer a broad range of opportunities for U.S. businesses in locomotive upgrades, telecommunications, railcar manufacturing and rebuilding, railcar maintenance and cleaning, and computerized ticketing.

To increase traffic speed, the Romanian railways will require more powerful, modern locomotives. U.S. companies are particularly interested in providing the 2100 HP diesel/electric locomotives. General Motors rehabilitated two prototypes, the first of 65 aging road locomotives built by Electroputere (Romanian producer of railway vehicles) to be modernized under a $100 million loan received from the Japanese Bank for International Cooperation (JBIC).

Telecommunications - Romania has made impressive progress in all of the ICT subsectors discussed below.

Basic telephony services are still the monopoly of the national operator Romtelecom, but as of January 1, 2003, will be liberalized. Romtelecom was partially privatized in 1998, when OTE (Greece) bought 35% of its shares. The Romanian government has announced its intention to sell more of its Romtelecom shares by the end of 2002. Schroder Salomon Smith Barney has been selected to advise the Ministry of Communication and IT on Romtelecom's further privatization. At mid-2002, Romtelecom had a total of about 4.5 million lines, of which 63% were digital. The average wire-based teledensity was 20% (30% in urban areas, but only 4% in rural areas, where some 2,000 villages still have no telephone service at all). Romtelecom's short-term plans emphasize further digitalization of its network in order to better support such services as ISDN, Voice over IP, and Internet. Following the market's deregulation, the entities best placed to offer fixed telephony, and thus compete with Romtelecom, will be cable TV operators, ISP's, mobile communications operators, and large public utilities (e.g. the national railways company and the national power transportation company.
Wireless communications. National operator SNR (Romanian Radio-communications Company) provides broadcasting and data transmission services through its national microwave network (partially digital), its national radio and TV transmitters and transponders network, and its satellite earth stations (fully digital). It also provides transmission capacities for public and mobile telephony, paging, trunked radio, cable TV, and data transmissions. In 2001, SNR inaugurated Romania's first pilot project for point-multipoint data transmission in the 26 GHz broadband. It also initiated a project to modernize and expand its broadcast infrastructure using Harris and Cisco equipment. In January 2002, SNR inaugurated a new platform at Cheia satellite earth station to increase data transmission capacity and offer VoIP services via satellite. In 2003, SNR will start competing with Romtelecom for fixed telephony, data transmission, and multimedia. SNR privatization will likely start in 2004.

Mobile communications. This sub-sector has developed dramatically in Romania over the last five years. Currently, there are four providers of cell telephony, with a total of 4.5 million subscribers: Mobifon - Connex (GSM 900 MHz), Orange (GSM 900 MHz), Cosmorom (DCS 1800 MHz), and Telemobil - Zapp (CDMA 450 MHz). The most revolutionary development on this market was the launching of the CDMA digital 450 MHz network in late 2001, the first of its kind in the world.
Cable communications, too, have experienced fast development, currently totaling more than 3.3 million subscribers. Leading cable TV operators are very well placed to offer internet over cable and, following the deregulation of the market, fixed telephony services.

Internet penetration in Romania is currently small (about 2.5 million users), but the growth rate of the sector is significant (5-6% per month). There are over 150 ISPs. Computer literacy and good English language skills of the population, the existence of a widespread cable TV network and a reasonably good penetration of mobile telephony (20%), as a basis for mobile internet, are factors which will support increased internet access. Factors negatively impacting internet development, as well as the development of e-commerce and e-government, include the insufficient number of PCs (only about 1 million for a population of 22 million) and the limited use of credit cards. While the number of stores that accept payment by credit card has increased, customers are not yet well-educated regarding their use. Many banks still lack the infrastructure necessary for clearing payments made via the internet.

Information Technology. This sub-sector is growing rapidly (about 30% per year). Because of the strength of its education system, the country has a large pool of highly skilled labor in engineering and electronics manufacturing, as well as an impressive number of software developers. About 45% of the computer hardware market is supplied by local system integrators, several of them having the status of original equipment manufacturers. Imports cover 55% of the market, and come mainly from such traditional U.S. suppliers as IBM, Hewlett-Packard/Compaq, and Cisco. Local companies supply about 25% of the computer software used in Romania, providing mainly special telecommunications programs and programs for industrial surveillance, control, and security. Of the country's more than 2,000 software development companies, many are exporting their services to EU and North American markets. Imports cover 75% of the software market. About 75% of all foreign software products in Romania are American. Practically all of the large U.S. software companies are present, with Microsoft and Oracle leading the import market.