Monday, May 28, 2007

Investors undeterred by Romanian politics

By: Cristina Muntean
Czech Business Weekly

Romania, which joined the European Union on Jan. 1, has become a top target for Czech companies wanting to expand abroad. Analysts say that the business environment remains strong despite the political unrest that climaxed with a national referendum May 19 reconfirming Traian Basescu as president. He was suspended a month earlier by the Romanian Parliament.

Enterprises already present in Romania are reporting high revenues and have plans to expand. Other firms said they were casting a close eye on rising economic indicators to calculate the right moment of a possible entry.

However, Czech investors point to two major issues that still hamper their development on the Romanian market: corruption and bureaucracy. But the situation is improving, analysts said. Romanian legislation meets European Union requirements, the economy is developing despite political precariousness, and the market will grow, driving investors’ profits upward.

Romania’s image abroad remains controversial. A Transparency International 2006 report on the perception of corruption, released shortly before Romania joined the EU, placed the country as the most corrupt country in the future EU-27. Despite such an image, companies look at long-term economic indicators when they decide to launch Romanian operations, according to analysts.

A record foreign direct investment (FDI) inflow in 2006 (see chart) and a sturdy gross domestic product (GDP) growth of 6.4 percent was reflected in the earnings of major Czech companies already operating in Romania.

“The most important investments are expected in the energy and infrastructure fields,” said Karel Zdìnovec, head of the trade department within the Czech Embassy in Bucharest. “We also expect in the forthcoming period some actions in the financial field, in the domain of food processing, paper-mill productions, ecological and IT projects, software and other special applications,” he said.

In 2006, top companies such as the electricity group ÈEZ, chemical and pharmaceutical company Zentiva, food manufacturer Hamé and the international private equity group PPF Investments recorded growth or expansion in Romania.

ÈEZ’s October 2005 purchase of 51 percent of the Romanian electricity distributor Electrica Oltenia for € 151 million (Kè 4.2 billion) was maybe one of the most resounding Czech investments in Romania. In 2006, ÈEZ Romania’s earnings before interest, taxes, depreciation and amortization (EBITDA) were € 60.3 million, compared to Electrica Oltenia’s 2005 net profit of € 21.3 million in 2005. Also in 2006, ÈEZ bid to purchase 67.5 percent of another major Romanian electricity distributor Electrica Muntenia Sud, but lost in favor of Italian group Enel that won the bid with a € 820 million offer. However, ÈEZ remains interested in further expansion, this time in electricity production. The Romanian government has recently announced its intentions to privatize three major electricity producers in Rovinari, Turceni and Craiova in the Oltenia region of southwest Romania, by 2008. “We’re interested in these projects and we would like to diversify our portfolio in Romania,” said Eva Nováková, ÈEZ’s spokeswoman.

“It’s normal for ÈEZ to be interested in investing mainly in the Oltenia region if the company wants to acquire synergies with its already owned distribution plant Electrica Oltenia,” said Constantin Nica, economic councilor with the Romanian Embassy in Prague.

Some of ÈEZ’s suppliers are considering launching Romanian operations, too. Czech producer of plastic switchboards for electricity and gas distribution DCK Holoubkov Bohemia is considering opening a production center in Romania, Lenka Chaloupková, DCK Holoubkov’s export manager told CBW. “We’re trying to cooperate with more and more Romanian partners and we’re considering launching a production plant, but for the moment we rather focus on enlarging our supplies,” Chaloupková said. DCK Holoubkov is already a supplier for ÈEZ and the German electricity group E.ON Èeská republika in the Czech Republic. Chaloupková said that the main challenges on the Romanian market are the different standards in switchboard production between Romania and the Czech Republic and the price sensitivity. “We need to maintain our quality, yet adapt to the local price conditions,” she said.

Top profits

Zentiva had a successful year in 2006. The Czech firm, which in September 2005 acquired the Romanian pharmaceutical company Sicomed for $102 million (Kè 2.1 billion)—saw its sales increasing by 27.2 percent in the first quarter of 2007 to reach € 23.2 million year-on-year. In 2006, Zentiva was the seventh-largest pharmaceutical company in Romania, with a 5.2 percent market share and sales of € 87 million.

For Zentiva, Romania makes roughly 19.8 percent of the total sales of the group and is the second market after the Czech Republic.

Food producer Hamé is another major Czech investor in Romania that’s considering expansion. Last year, Petr Šubrt, Hamé’s general director for Romania, told the Romanian financial daily Ziarul financiar that Hamé is “ready to buy whatever business” it makes sense to invest in. He added that the business can’t grow organically anymore “but needs expansion.” In 2006, Hamé’s turnover grew up € 5.1 billion in 2006 from € 4.3 million in 2005.

The Romanian service sector also lures investments. In early 2007, private equity investment fund PPF Investments (PPFI) purchased two insurance houses in less than one month (see “PPFI grows in Romania,” CBW, March 5, 2007).

PPFI was reportedly interested in purchasing a share in the hotel chain Continental Hotels, operator of the Ibis brand in Romania. The management of Continental hotels denied rumors about possible negotiations and, on May 14, decided to raise its capital by € 14 million and open six more new hotels in Romania totaling 1,600 rooms by mid-2010. At the end of 2006, Continental Hotels had a turnover of € 24.3 million, compared to € 22.3 million in 2005. PPFI declined to comment on its expansion strategy in Romania.

Shadow of corruption

Besides large investors, many smaller firms gained more confidence in Romania after its accession to the EU. An example is the Czech law firm Koneèná & Šafáø, which will open its first office abroad in Romania in the second half of 2007. Domestic consultancy M.C.Triton is also examining the option of opening an office in Romania (see “Consultancies see growth and consolidation,” CBW, March 19, 2007).

“Generally, the Romanian environment is business-friendly, but there are still two problems: corruption and bureaucracy,” said Pavel Šafáø, partner with Koneèná & Šafáø.

Šafáø said that corruption is noticeable at two levels. “Whenever you need something and the other person isn’t obliged to serve you, there is an automatic expectation that you will pay for it,” he said. The other area of corruption is on the decision-making level where, for example, “public tenders aren’t very transparent yet.”

Bureaucracy is another factor that affects Romania, Šafáø said. “Day-to-day operations can flow smoothly, but if a company needs a more sophisticated transaction, the number of necessary permits and authorizations is extremely high,” he said.

However, “the business is booming and we expect to see growth and reach [a staff of] between 10 and 15 lawyers in the next five years,” Šafáø said. “We sometimes feel difficulties on access to tenders, together with lack of information and corruption in different stages of decisions,” Zdìnovec said. “There are still big differences between the Romanian regions from the point of view of development of infrastructure and the conditions for the business activities,” he said.

Romania’s capital market didn’t react when the Parliament suspended President Basescu April 19. “Business is stronger than politics, and the investment climate has not been noticeably affected by the political difficulties,” said Victor Kevehazi, senior partner with consultancy KPMG Romania. Kevehazi said that “most investors look at Romania’s long term potential, and so they are not too concerned about short term political instability.”

Rather, the greater concern would be a longer term political instability that may affect or impede legislation and have a greater impact on investors. “The only potential difficulty for the investment climate would be if the political instability drags out for a long time, and important legislation does not get passed,” he said, adding that Romania also has the chance to access significant amounts of EU funding, which “present a great opportunity for the country to modernize its infrastructure, with corresponding benefits to the business environment.” These funds could be jeopardized if “Romania does not have an efficient government to administer their disbursement,” he said. “The business community and citizens consequently need to be vigilant, to ensure that government does not squander this opportunity for the country,” Kevehazi said.

Who’s louder?

The open conflict between Basescu and Prime Minister Calin Popescu Tariceanu (National Liberal Party, PNL) made the European Commission (EC) wonder if Romania is able to continue the reforms it promised before its EU accession.

Basescu was suspended by the Romanian Parliament April 19 on grounds of side-stepping the Constitution by alleging that members of Tariceanu’s government have close connections to the so-called “oligarchs”—Romania oil, energy and media moguls whose businesses started to be investigated after the 2004 elections that saw Basescu’s coalition of center-right parties win the polls.

The Romanian Constitutional Court (CSJ) rejected Parliament’s claim that Basescu subverted the law, but the opinion wasn’t binding.

The Parliament then voted by a wide margin to suspend the president. The decision provoked waves of protests and fears that reforms in Romania would be stopped. The results of the May 19 referendum, when Basescu was reconfirmed as president with roughly 75 percent of votes, lead to hopes among those in the business community that Romania will follow its positive development. But the referendum was just one of several issues in the conflict between the president and Parliament.

In June 2007, Romania expects an EC report on justice reforms that will evaluate the current state of affairs. If Romania doesn’t meet the EC’s criteria, a “safeguard clause on justice” can be activated against the new EU member, which could affect the country’s international image. “We have no signals that this might happen,” said Dan Balanescu, first secretary with the Romanian Embassy in the Czech Republic.

Analysts also expressed a hope that the country will return to normalcy. “We hope that with the referendum out of the way, there will be a return to more coherent government,” KPMG’s Kevehazi said.

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Flat tax leads Romanian incentives

Romania’s corporate flat tax of 16 percent remains one of the country’s strongest investment incentives, experts say.

According to information provided by the Romanian Agency for Foreign Investment (ARIS), Romania also offers a varied range of fiscal incentives such as nontaxable revenues, including dividends received by a foreign company from its Romanian subsidiary, or the deduction of different expenses incurred with fields such as work safety, advertising and marketing, travel and accommodation of business trips, professional training of employees or research and development (R&D).

Expenses for health and private pension insurance premiums or taxes and contributions paid to nongovernmental organizations also are eligible as limited deductions.

Besides these incentives, there are also local tax incentives such as building or land tax exemptions for five years. “While the introduction of a flat 16 percent rate for corporate and personal income from the start of 2005 was a step forward, taxation in Romania is still complicated and bureaucratic, with a serious lack of transparency in many cases,” said Victor Kevehazi, senior partner with consultancy KPMG Romania.

Moreover, employers who hire graduates from a general or vocational school with an open-end contract will receive the equivalent of the monthly minimum wage for 12 months. This amount can increase if the employer takes on board a secondary or university graduate. As of May 2007, an employer that hires a vocational school graduate will receive roughly € 1,428 (Kè 40,200) per year, while employing a university graduate will allot roughly € 2,142 per year. Similar benefits are given to employers that hire unemployed people over 45 with open-end contracts. Companies can also receive a further benefit of 50 percent co-financing for training expenses for no more than 20 percent of the entire staff during one year.

A new law on investment incentives in Romania is expected to be ready before the end of 2007. Sorin Vasilescu, CEO of ARIS, told CBW that the new law will set up measures that will stimulate “a balanced regional development,” with the creation of new jobs mainly in areas with high unemployment, and it will encourage investments into R&D and environment-focused activities.

“The main incentive will, however, remain the flat tax, as companies always look at how much of their earnings they have to pay to the state,” said Constantin Nica, economic councilor with the Romanian Embassy in Prague.

He said that, for example, local taxes on buildings are set at a standard rate that is very high compared to neighboring countries, but holds the possibility of significant reductions for certain investors. However, there is not yet a clear definition of the criteria for awarding these concessions. “Such lack of clarity creates serious potential for corruption,” he said.

Between 2004 and the first half of 2006, ARIS mediated 62 investment projects valued at € 2.9 billion that created 33,105 new jobs. No Czech investments appear among the listed projects. However, Vasilescu said that ARIS mediated some 73 investment projects whose details, though confidential, are valued at € 2.9 billion and which created 21,945 new jobs. Comparatively, in 2006 Czech state business development and investment agency CzechInvest mediated 176 projects valued at roughly € 4 billion, which generated 34,824 new jobs.



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