So far, so good
The centre-right coalition government elected in November 1996 has introduced new laws which have encouraged foreign investors. Under the new prime minister, Victor Ciorbea, most price controls were lifted in the first six months of the year while the foreign exchange market has been liberalized. The National Bank of Romania also intends to make the Romanian leu convertible under article VIII of the IMF statute by the end of this year.
The changes are long overdue, as Romania has stagnated for most of the past eight years. Many of the economic vestiges of the communist state were left intact under the left-wing governments that ruled after the fall of the dictator Nicolae Ceausescu. “It was a semi-socialist economy until 1996. Few prices were freely determined and the economy was still essentially controlled by the state,” says Kadri Samsunlu, assistant general manager at brokerage Global Valori Mobiliare.
In the first half of the 1990s, Romania also earned a poor reputation for its commitment to democracy and the protection of minority rights. The overthrow of Ceausescu is now regarded as more of a palace coup than a true handover of power. Romania’s record was tarnished by the presidency of Ion Iliescu, who was in power from 1990 until November 1996. Iliescu’s authoritarian style had become clear in June 1990 when he encouraged coal miners to travel to Bucharest to break up student demonstrations.
Romania now has its first chance to follow the example of the leading reformist countries in central Europe and pursue low inflation and growth within a more democratic framework.
Romania began mass privatization in 1992, but the programme faltered in mid-decade. The State Ownership Fund (SOF) still holds controlling stakes in a large number of companies. Privatization brought in neither fresh capital nor new technologies and most companies are still using equipment from the 1970s, when Romania was one of the most open countries in eastern Europe. Industrial production declined at an average rate of 20% between 1990 and 1992. Slow growth from 1993 to 1995 was more of a correction than evidence that reform was bearing fruit.
The structure of Romanian exports (which totalled $8 billion in 1996) illustrates how much restructuring is needed before Romania matches the achievements of Hungary or the Czech Republic. Exports are still dominated by low-margin, highly competitive products, such as oil derivatives, fertilizers and textiles sold through sub-contracting arrangements.
The balance of payments has been a problem for most of the 1990s with the current account deficit representing 4.6% of GDP in 1995 and 6.6% in 1996. Romania’s low credit rating forced it to close the gap with loans from the IMF, which in the first half of the 1990s arranged five separate facilities. All were prematurely suspended because of the government’s failure to carry out promised reforms.
All this, combined with the high and unpredictable rate of inflation, has impeded the development of the banking system. Confidence evaporated in the mid-1990s when a large number of savers shifted their money into pyramid funds while several of the newly-established private banks collapsed.
While the new Romanian government has won respect for the acceleration in reform, in the short run the economy is deteriorating. Inflation jumped after the removal of price controls with the monthly rate reaching 19% in February and 31% in March before falling to 2% in July. “We expect the year-on-year rate to be between 110% and 120% by the end of this year,” says one analyst. “The economy will probably contract 3% this year with zero growth in 1998.”
The big test of the new government’s commitment to reform will be the pace of industrial restructuring, especially privatization. Here the evidence so far is mixed. Romania’s agreement with the IMF required it to close down several loss-making factories, including two refineries, the Tomistex textiles factory in Constanta and Roman, a lorry manufacturer in the city of Brasov. But in August the signs were that Roman would not be closed after all.
Privatization has actually slowed down under the new government. “The SOF is controlled by the Peasants Party,” explains one analyst, “which still focuses on restructuring rather than privatization”. However, there were signs in July that the government would speed up sales and that foreign investors were responding enthusiastically. It was preparing to appoint foreign advisers for a series of strategic sales and in August it was preparing the sale of its 62% stake in Romcim, the country’s largest cement manufacturer. The tender attracted the interest of many of the world’s largest cement producers, although in late August it was unclear if the deal would go ahead.
The planned sale of Romcim signals a change in the pattern of foreign investment in Romania, most of which has been in low-risk cash generating industries. “The first companies to go were in consumer goods production, such as detergents, beer and ceramics,” says Guy Verduystert, executive president of Creditanstalt Financial Advisers. “Much of the rest of the industrial base has been depleted and serious investment is required.”
The interest in Romcim suggests that foreign investors are prepared to take greater risks in Romania. This may bode well for the future as the government is preparing an even more ambitious privatization: the sale of Rom Telecom, the telephone utility. This deal, for which Goldman Sachs has been appointed adviser to the ministry of communications, will start with sale of 30% to a foreign strategic investor to be followed by an initial public offering.
Although there was strong foreign demand when Hungary and the Czech Republic sold their telephone companies, analysts suspect that Romania may find it harder to convince foreign buyers. The system is regarded as one of the least developed in central Europe. Mobile telephony has eroded Rom Telecom’s revenue base.
On the positive side, the sheer size of the Romanian domestic market, with a population larger than Hungary and the Czech Republic combined, means the stake in Rom Telecom is estimated by investment bankers to be worth at least the $1.45 billion paid in 1995 for a similar stake in SPT Telekom of the Czech Republic.
As Romania’s reputation has improved, it has become easier for the government to borrow in the international markets. In June it tapped the Deutschmark sector of the Eurobond market for the first time, raising Dm600 million in its largest and longest-maturity borrowing to date.
“We managed to increase the size from Dm500 million and this was the first time that we had borrowed over a five-year tenor,” recalls Daniela Cernat at the ministry of finance. “The deal was also important because we managed to diversify the range of investors buying our bonds.”
Romania, which launched its first public Eurobond in June 1996, has until now been restricted by its credit rating to issuing mostly short-term debt with maturities of three years and less. Although the state has only $4.2 billion of direct international debt and $2.2 billion of guaranteed borrowings (a very low level of debt by international standards) the ratings agencies rate Romanian debt as non-investment grade. Standard & Poor’s rating is BB minus and Moody’s Ba3. Investment bankers in London believe the country deserves better: Russia, for instance, is rated one notch lower at Ba2 by Moody’s, as is Moldova, where until recently there was a war going on. “We hope that we will be upgraded this year,” says Alexandra Stamanichi, head of the finance ministry’s domestic public debt division.
The government has set a $3.2 billion ceiling on its foreign borrowing in 1997 and has not decided whether it will tap the Eurobond market again this year. But Cernat says the country is considering issuing a yankee bond. This would undoubtedly help extend the maturity of its debt.
The cities of Bucharest, Brasov and Constanta, which have been preparing their inaugural issues, will not now go ahead with them this year. The government has barred them, together with other state borrowers, from tapping the Eurobond market during 1997.
In the interim, the syndicated loan market is becoming a more important source of finance for Romanian companies and banks. In July, Renel, the state electricity concern, mandated Citibank to arrange a $150 million revolving credit at a spread of 95 basis points over Libor. This was the first time that a Romanian borrower has tried to raise funds at below the 100bp barrier.
However, the maturity of the Renel credit is only one year and there have been almost no long-term project financings, despite the massive demand for new funds. “Part of the problem is the availability of the sovereign guarantee,” says Robert Dolan, vice president and outgoing senior country officer at Chase Manhattan’s branch in Bucharest. “You would have to have a very interesting story to tell to be able to go to the markets today without a guarantee.”
In search of capital
Romania’s efforts to create a fair and transparent stock market are paying off. Political risk has diminished and the country’s two markets are attracting foreign cash
Of the large number of stock markets set up in eastern Europe, only one – the Warsaw exchange – has developed into an efficient capital market where companies can raise funds with ease and stocks are priced fairly. Two years after its inception, the Romanian equity market is on course to achieving the same goals.
As in Poland, the creators of the stock market paid a lot of attention to market infrastructure; brokers regard the Romanian systems for trading, settlement and registration as among the best in the region. Likewise, Romania’s national securities commission has worked hard to enforce the securities legislation and make the market transparent and fair.
But the fundamental structure of Romania’s equity market differs from Poland’s. The Poles focused their energy on the Warsaw Stock Exchange, where about 100 companies are traded and there are high disclosure requirements. In Romania there are two contrasting markets. One, the Bucharest Stock Exchange (BSE) opened in June 1995 and now has about 50 listed companies with a combined capitalization of $675 million. It is dwarfed, however, by the Rasdaq over-the-counter (OTC) market where 3,800 companies are traded and daily turnover averaged $4 million in July (double the BSE figure). Rasdaq is capitalized at $2.3 billion.
Romania’s approach to privatization meant it had to create two markets, rather than one. Seven thousand companies were privatized simultaneously. Each adult received a free voucher to purchase shares, creating 16 million shareholders. Many of the companies were too small to meet rigorous listing requirements, yet people naturally wanted to be able to sell their shares. Rasdaq, which was developed with help from the US government, opened in November 1996 to provide a marketplace for these transactions.
Foreign portfolio investors began taking Romania seriously after the November 1996 elections brought to power a government that was committed to reform. That mitigated the political risk which had thus far outweighed the country’s innate advantages.
“Romania is attractive now because it is virgin territory,” says Margot Olcay, manager of research at Global Valori Mobiliare, a brokerage in Bucharest. “Many of the investors who come here already have experience of other emerging markets, such as Russia or Hungary and they realize the potential for capital gains. Romania is very cheap compared to Hungary or Turkey, for example, if you consider companies’ asset values.” She adds: “This is a country of 23 million people, who have very low incomes and consumption patterns. That will change, and after the economy is restructured, companies will increase both the quality and quantity of their production.”
Events elsewhere in eastern Europe this year have also made it easier to sell Romanian equities. “The Russian market is very volatile,” says Marcel Cobuz-Bagnaru, executive president and CEO of Creditanstalt Securities in Bucharest. “The Czech market is depressed by the macroeconomic collapse, and investors have been holding back from Poland because they are waiting for elections.” He goes on: “In contrast, Romania offers quite a good perspective for 1997 and 1998. The macroeconomic situation is stabilizing.”
Investors adventurous enough to have bought Romanian equities in 1996 have made big gains. According to Creditanstalt data, share prices have risen an average of 400% on the BSE in local currency terms and 900% on Rasdaq, despite a correction during the summer. Brokers expect share prices to continue increasing – albeit at a slower rate – even though the economy is contracting this year and inflation may top 100% for the full year. Corporate earnings are likely to fall, making the Bucharest market unattractive to investors who focus exclusively on price/earnings ratios.
Despite the large number of stocks that are being traded, foreigners have focused on a handful of companies that have achieved benchmark status. They include the two largest BSE-listed companies: Azomures, a fertilizer producer which was capitalized at $107 million in July; and Oltchim, a chemicals producer. On Rasdaq, there has been demand for Romcim, Romania’s largest cement producer, and the steel company Sidex, which is the largest traded company with a capitalization of over $300 million.
“Investors’ horizons are broadening,” says Kadri Samsunlu, assistant general manager at Global Valori Mobiliare. “Last year Azomures and Oltchim accounted for 80% of turnover. Investors now have more options: we are now recommending 15 companies.”
There are a large number of companies, however, that foreigners do not touch because it is so hard to source stock. “The capital market is illiquid because of the dispersal of share ownership and because there is a lack of experienced brokers able to collect shares from Romanians,” says Creditanstalt’s Cobuz-Bagnaru. Turnover has increased this year, but still averaged only $1.4 million a day on Rasdaq in the first four months of 1997 and $1.1 million on the BSE.
In addition, brokers note that foreign interest is restrained by the limited range of industries represented by traded stocks. So far, only industrial companies have been privatized. The state still owns utilities which would attract many other investors. There are as yet no banks listed on the BSE or Rasdaq, although Banca Transylvania, based in the northern city of Cluj, is considering listing its shares on the BSE in the autumn of 1997.
So far, there have been two main groups of foreign portfolio investors in Romania. Hedge funds moved into the market last year in the expectation, subsequently proved correct, that prices would be re-rated after the election. Many of them are valuing Romanian stocks on ratios such as stock price versus capacity or output, the same technique they used in Russia. “Price/earnings is not the most relevant function,” remarks Creditanstalt Securities’ Cobuz-Bagnaru. “It is better to look at capacity, assets and market share.”
Global’s Samsunlu cites Romcim, Romania’s large cement producer, as an example. “Its price/earnings ratio is about 100 and few investors will buy if you tell them that. But if you consider price per capacity it is very cheap.” He goes on: “You should also bear in mind that a stake is about to be sold to a strategic investor, which will increase efficiency and modernize the plant.”
According to one analyst, demand for cement should pick up as industrial production recovers, while another attraction of Romcim is the fact that it has a plant strategically located near the river Danube.
Hedge funds have justified their buying into Romanian refineries with similar underpricing arguments. They trade around $30 per tonne of capacity, compared to $300-$400 in other comparable markets. “The refineries have lost money in recent years because petrol prices were kept artificially low,” says one analyst. “So they look bad if you value them by their earnings, but attractive if you think of the potential for price appreciation.”
This year, the demand for Romanian equity has been fuelled by a rising number of specialized funds dedicated to Romania or the surrounding region. Regent Pacific has set up a $180 million fund for the Balkans, which will have a Romanian weighting of about 20%. Investmentbank Austria has a $60 million Romanian fund, while Société Générale has a $50 million fund. The Romanian Growth Fund, set up by Global Securities, has raised $25 million.
Despite the generally high quality of the market infrastructure in Romania, few mainstream investors have bought Romanian equities directly. One barrier has been Romanian legislation: until recently it was unclear whether portfolio investors could repatriate profits. In June, however, the government announced it was going to issue regulations to clarify the situation. “The reason for the delay,” says one banker, “is that the government does not completely understand how portfolio investment works and is obsessed with the fear of it leading to a Mexican-style meltdown.”
Another problem for some funds is custody. The local subsidiary of ABN Amro is regarded as offering high-quality services, but one broker observes: “Some of the US funds are waiting for Citibank to start providing custody.” Another hitch, as Global’s Samsunlu explains, is that the major foreign custodian banks do not have custody accounts at the stock exchange. “So if I buy shares for a foreign investor, I cannot transfer them to their custodian, but have to say that the shares on my account are frozen.” Some conservative investors cannot accept that solution, while Samsunlu notes that freezing shares is creating a mounting volume of paperwork for the brokerage.
Many of these problems are being ironed out, say brokers. The challenge for the equity market will be meeting the huge demand for funds from Romanian corporates over the next three years.
“There are several successful private companies that have grown over the past few years and will seek new capital,” says Michael Muellner, general manager of Eastbrokers in Bucharest. “The test will be whether the stock market can provide them with funds at a competitive price.”
Reforms in the debt market
The Romanian ministry of finance is reforming its small, but growing, domestic bond market in an attempt to increase the average maturity of its debt and bring in new investors. The market was founded in 1994, but took off in April when the ministry abandoned its previous subscription technique for selling treasury bills (which constitute the bulk of the debt) in favour of a system of auctions.
“It is very important to have a real level of interest rates and previously the rate was pre-announced,” says Alexandra Stamanichi, head of the domestic public debt division at the ministry of finance in Bucharest. “But instead of rising, interest rates fell after we introduced auctions.”
At the same time, the ministry introduced several measures to promote secondary trading of T-bills. The reaction from the market took even the ministry by surprise. Rates plummeted from levels above 100% at the beginning of 1997 when inflationary expectations were fuelled by the removal of price controls. Since then, huge demand from banks has driven yields down to around 35% during the summer. “There are two reasons for this,” says one broker. “Liquidity in the banking system is quite high, because individuals are not investing elsewhere and loan demand is low. Also, expectations for inflation have declined sharply.” However, bankers doubt that yields can fall much further, as interest earnings are taxed at 38%.
Nevertheless, the finance ministry is hoping to extend its existing three-month and six-month issues of T-bills by starting to issue paper with maturities with one year and one day. “We will issue at longer maturities if there is demand,” says Stamanichi. “But not beyond two years for the moment.” T-bills are issued in dematerialized form and the National Bank of Romania acts as paying and selling agent. Outstandings totalled Lei9.2 trillion ($1.3 billion) in July.
So far, the market has been dominated by Romanian banks. The only foreigners allowed to buy T-bills are those domiciled in the country (which in practice means foreign banks). However, some foreign investors have managed to circumvent the effective ban on their participation by buying T-bills in synthetic form from Romanian banks. According to Stamanichi, the ministry is also considering opening the market directly to foreigners. All the evidence suggests that would fuel demand and help the ministry’s plans to issue longer maturity paper.
