Outsiders progress slowly in Romania

By Katalin Tóth

The wild wild East

Our neighbor to the east, Ro­ma­nia, has been overlooked for decades by Hungarian companies as a serious destination for investment, owing mainly to the destructive legacy of the one-time Ceausescu regime, and – despite much obvious potential – hitherto weak economic growth.

But things are changing, and changing rapidly. The region’s third largest country is growing at a remarkable rate, and the previously unthinkable idea of Romania becoming an EU member is now an imminent reality.

Romania’s GDP rocketed by 8.3% in 2004, and is expected to grow by 5.5% this year. Inflation has finally come down to single digits, and is predicted to fall to 7% in 2005. With few exceptions, every sector of the economy is booming – especially construction, retail and services.

Tapping into this vast and largely unexploited market is, however, no cakewalk. The sheer scale of possible returns means that small Hungarian firms will often go up against multinationals when seeking a foothold on the Romanian market. Nonetheless, SMEs are making headway in niche markets such as IT, while Hungarian powerhouses like OTP Bank are gaining a presence in what most analysts agree will be the most dynamically growing market in the CEE over the next five years.

Romania is a rapidly growing market promising higher returns than most developed markets, with quickly growing demand and a still relatively inexpensive workforce and services. However, as entrepreneurs and consultants speaking to the BBJ stressed last week, investors should also take into consideration factors such as cultural differences, lack of skilled management and lax fiscal discipline, which necessitate a special approach to this market of some 22 million people.

GDP in Romania grew by 8.3% in 2004, and is expected to increase by 5.5% this year. As the economy is growing much faster than in most European countries, while inflation is expected to decline to 7% in 2005, almost every sector of the economy is booming, especially the construction industry, and the retail and services sectors.

Speaking at a conference hosted this year in Budapest by economic news portal portfolio.hu, Marc Cannizzo, partner at Romanian corporate finance consultancy Osprey Partners, noted that average wages in Romania have grown in real terms to the equivalent of about €180 per month, household purchasing power is on the rise, and consumer finance products – including mortgages – are increasingly available.

“There is a vast, mostly untapped market in Romania,” observed Attila Fazakas, CEO and owner of PS Index s.r.l., which operates Romanian household appliances store chain Profi Center. “Besides strong demand, investors in Romania can expect a quick return on their investment of two to five years, while – in my experience – it is between four and seven years in Hungary, for example.”

The high profit margin in Romania is due to lower costs, especially wages, Fazakas noted. From this, he added, it follows that almost all services are much cheaper than those in Hungary or elsewhere in Europe.

“For example, the cost of maintaining a fleet of cars is 60%–70% of the equivalent cost in Hungary, and half of that in Western Europe,” he said.

Low wages, however, often also translate into lower productivity, especially in counties of Romania outside the heavily ethnic Hungarian-populated region of Transylvania, Fazakas warned.

“At my company, I introduced a performance-related remuneration system, but sometimes it seems impossible to motivate employees above a certain level,” he said. “When I asked one of my dealers in [the region of] Moldavia why his performance was lower than that of dealers in another county, and [pointed out] that if he worked more he could make more money, he answered that he was satisfied and didn’t need more money.”

Another factor hindering Romanian investments is the shortage of skilled and experienced management, Cannizzo said. Fazakas agreed, saying that traditional state-owned universities don’t produce enough professionals, while students of numerous private universities are poorly prepared for their future jobs.

Making it pay

All do not share this dim view of doing business with Hungary’s neighbor, however. The managers of one Hungarian training firm that recently opened a Romanian affiliate related entirely different experiences.

“We had several worries and preconceptions about working with people from a different cultural environment, but the people we interviewed, and later employed, were very educated, experienced, and familiar with the European management style,” said Attila Kriaszter, communications director of Develor Rt. “Romanian workers are eager to learn anything that comes from the EU. It came as a very pleasant surprise for us.”

Some major Hungarian firms with investments in Romania have already contacted Develor, and the training firm plans to organize training programs for SMEs too, Kriaszter added.

Besides cultural differences, the most serious problem for Romanian firms, and for potential investors from abroad, is under-capitalization and a lack of fiscal discipline at these firms, explained Ferenc Gábor, a consultant at Osprey Partners.

Fazakas pointed to problems with payment discipline.

“It’s a common thing that customers don’t pay or are very late with payments, partly because many don’t have operating capital, or have financial problems, while others are just not in a hurry to pay because being late with payments is cheap financing for them,” Fazakas said. He added that some big companies abuse their strong positions by paying late to smaller suppliers, and foreign investors in Romania must thus be tough negotiators.

Gábor cited an example of a mid-sized Transylvanian manufacturer, whose biggest customer did not pay for a long period, as it did not believe its smaller business partner would dare suspend their contract and stop shipping goods until regular payment resumed. When the supplier did move to suspend the contract, payments from the customer became more regular, the Osprey consultant said.

Gábor added that there is a blacklist available to commercial banks and companies, so that investors can avoid lending to insolvent clients. The Romanian Finance Ministry also publishes the latest balance sheets of companies on the internet.

While late payments can already be enough to destabilize a company, tax and other legislation also present potential risk factors.

The pace of development is very fast in Romania, and the legal system often fails to keep up, according to Fazakas. Tax laws are especially sensitive, he said, because many provisions of Romanian tax law are open to several interpretations, while the taxpayer cannot ask for a legal interpretation from the tax authority, as in Hungary or other EU countries.

“One time we sent a letter about a tax issue to the Romanian tax authority, explaining our interpretation of a provision and asking for theirs,” Fazakas recalled. “In the answer, the clerk just repeated the text of the law, and avoided taking a stance on the issue.”

Tax incentives

In Romania, investment incentives are equal for both domestic and foreign investors, and are available for significant investments or for investors in special economic zones, according to Róbert Heinczinger, tax partner at Ernst & Young Advisory Kft.

Investments that exceed $1 million are exempt from customs duties on new equipment. Local authorities may also grant an exemption or reduction of land tax for land related to the investment for the period of execution, up to a maximum of three years from the beginning of the works. Investors may also benefit from national grants for research and development, regional aid, and subsidies for SMEs, training, restructuring, large investment projects and environmental protection.

Employment subsidies up to 70% of the minimum monthly gross salary are available for hiring unemployed persons, recent graduates, individuals over 45 years old, and members of other special or disadvantaged categories.

Grants from the Environment Fund, which are managed by the Romanian Environment Ministry, are available for projects promoting clean technologies, eco-labeling and other environment-friendly technologies.

Industrial, scientific and technological parks are exempt from building tax and land tax, while investments in construction or internal infrastructure development in industrial parks are given a one-off allowance of 20% of the investment value, granted as a reduction of the taxable base for profit tax, until Dec. 31, 2006.

Tax advisors also pointed out that investors in free-trade zones can benefit from a tax exemption until June 30, 2007, if, by July 1, 2002, they carried out investments amounting to a minimum of $1 million in depreciable tangible assets. This exemption does not apply, however, if more than 25% of the investment was sold within one year. Operations within the free-trade zone are VAT-exempt.

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