Economic Effects of the Financial Crisis in Central and Eastern Europe: How is Romania Different?

1. “Efectele crizei economice in Europa Centrala si de Est - ce diferentiaza România?” Ionut DUMITRU, Economist-sef Raiffeisen Bank

2. Contraction size factors • Degree of dependence on external financing; • Degree of trade openness; • Export structure; • Exchange rate regime; • Size of macroeconomic imbalances; • Reliance of growth on cycle-sensitive and volatile sectors (construction, cars); • Countries with the largest macroeconomic imbalances (especially current account deficits and inflation) and high dependence of commercial banks on external liabilities have seen the largest economic adjustments in 2009.

3. The regional context:Economic activity decelerated rapidly in all CEE countries • Depreciation pressures for local currencies • Sharp fall in domestic demand (consumption and investments) • Increase in unemployment rate • Freeze of lending activities High external funding needs and Low inflows of foreign capitals Overheated economies which relied in a large extent on external financing suffered the most ! GDP, consumption and investments: H1 09 vs. H1 08 (% yoy) C/A deficit in 2007 and change in domestic private demand (H1 09 vs. H1 08 in %) Source: Eurostat, IMF, Raiffeisen RESEARCH

4. Dependence on external funding – the main vulnerability • The high current account deficit was the main macroeconomic disequilibrium; • The CA deficit fuelled the dependence on external funding; • But Romania was better positioned than other new EU member countries in terms of external funding dependence. Current account deficit (% of GDP, 2008 Q4) External funding dependence (% of GDP, 2008 Q4) Source: EUROSTAT, JEDH, Raiffeisen RESEARCH Note: Positive values denotes expected external outflows in the next year which requires funding

5. The regional context:Foreign capital inflows in CEE countries slowed down Dynamics of private external debt (% of GDP) Net inward FDIs in H1 09 vs H1 08 (EUR mn) Change in stock of private external debt (Q2 09 vs Q4 08, %) • FDI inflows decreased also substantially in the first half of 2009 • Romania was not the most affected: • Romania still recorded positive net FDI’s in 2009 (EUR 3.1 bn in Jan-July ) • Contraction rate (-48% yoy in Jan-Jul) was the lowest as compared with other CEE countries • External debt of private sector increased rapidly in last years • However, credit inflows slowed down substantially in last three quarters (stock of debt decreased in most of the countries) • Romania was not the most affected: stock of the private external debt has decreased, but in a less extent that in other countries Source: World Bank, websites of central banks, Raiffeisen RESEARCH

6. Fast increase in external debt in last years, but good coverage with international reserves • In spite of rapid increase from last years, external debt is still at a low level; • Large and very comfortable FX official reserves. External debt, public and private sector (% of GDP, 2008) FX reserves (% of country’s expected outflows, 2008) Source: EUROSTAT, JEDH, Raiffeisen RESEARCH Note: External debt service = Short-term external debt (initial maturity) + +15% of long-term external debt (initial maturity)

7. Most of CEE economies have a high degree of economic openness • Exports account for a large share of GDP in case of most CEE countries • Large dependence on the external markets (especially Euro zone) • Romania and Poland, the largest CEE countries, depend in a less extent on the exports Total exports (% of GDP) Total exports (% of GDP, 2008) Note: CEE countries inludes Czeck Republic, Slovakia, Poland, Hungary, Romania, Bulgaria Source: IMF, Eurostat, Raiffeisen RESEARCH

8. High external debt of the banking sector, but better positioned than other NMS countries • External debt of the banking sector is important, as banks had to take funds from abroad in order to extend loans in FCY (more attractive for households and companies); • Romania is better positioned that other new EU member countries. External debt of banking system (% of GDP, 2008 Q3) External liabilities of banking sector (2008 Q3) Source: EUROSTAT, JEDH, ECB, Raiffeisen RESEARCH

9. The regional context:Exports and imports slumped • Sharp contraction in domestic activity triggered a plunge in imports • Imports fell the most in overheated economies • Romania recorded the fourth highest contraction rate among the new EU member countries in Jan-Sep 2009 • Fall in external demand triggered a sharp decrease in exports also • Romania recorded the lowest contraction rate among the new EU member countries in Jan-Sep 2009 Imports and domestic private demand Value of exports in Jan-Sep 2009 (% yoy) Source: Eurostat , Raiffeisen RESEARCH

10. The regional context:Economic activity moved close to the bottom • It seems that economic activity is close to the bottom: • After sharp falls at the end of 2008 – beginning of 2009, the industrial output started to recover in most of the countries • Economic sentiment indexes improved over the last months • Performance of Romanian industrial sector was much better than all other CEE countries except Poland Level of industrial output (2008 H1 =100, 3 months average) Industrial output in Jan-Sep (% yoy) Economic Sentiment Index (ESI) (3 months moving average) Source: Eurostat , Raiffeisen RESEARCH

11. The regional context:Unemployment rates have increased • Unemployment rates have increased rapidly in last year, especially in Baltic countries • In case of Romania, increase in harmonized unemployment rate was low. However, the recorded unemployment rate (based on officially recorded unemployment) increased faster. Latest unemployment rates (Eurostat harmonized methodology, ILO) Change in unemployment rate from June 2008 For Romania, both ILO rate and recorded unemployment rate: • ILO rate at 6.4% in Q2 2009 • Recorded unemployment rate at 7.2% in Oct 2009 Source: Eurostat, ANOFM, Raiffeisen RESEARCH

12. The regional context:Some of the countries asked for external financing packages • Facing with high external debt service and expected lower inflows of foreign capitals, some of the new EU member countries (Latvia, Hungary, and Romania) asked and received financial assistance form the European Commission and the International Monetary Fund • to limit the pressures for currency depreciation (Hungary, Romania) • to smooth the economic adjustment • External debt of public sector replaced external debt of private sector External financing packages agreed with the IMF External financing package for Romania • In March, Romania secured a 2-year external financing package amounting to EUR 20 bn • The package covers external financing gap for 2009 and 2010 • Hungary, Latvia and Romania received also financial assistancefrom the European Commission and World Bank Source: World Bank, IMF , Raiffeisen RESEARCH

13. The regional context:Sentiment of investors improved in last months • All regional currencies depreciated at the end of 2008 – beginning of 2009, while CDS quotations increased also. • However, starting February the investors’ sentiment improved and part of the losses were recovered • In 2009, the leu was much stable than the other floating regional currencies: • Interventions of central bank in the FX market • Tight control of central bank over the liquidity in the money market • Lower trading volumes in the FX market Regional exchange rates CDS quotations, 5 years, USD segment Source: Bloomberg , NBR, Raiffeisen RESEARCH

14. Budget deficit vs economic growth in 2008

15. Main macroeconomic indicators, 2008