1. Slide 1 / 28.04.2015 Romania and the international financial and economic crisis Ionut DUMITRU Chief-Economist Raiffeisen Bank Romania February 2009 “Challenges and Opportunities during an Economic Downturn - A Practical Guide in the Romanian Market”, American Chamber of Commerce in Romania

2. Slide 2 / 28.04.2015 International crisis – multiple causes Low interest rates and ample liquidity in the markets triggered a decrease in risk aversion and an undervaluation of risk worldwide –Investors were more eager to invest in risky assets and in risky countries (ignoring increasing imbalances) –There was a asset price bubble (i.e. housing bubble in the United States) –Underestimation of risks for sophisticated financial instruments –Explosion of subprime lending and securitization activities in US –Lax regulation of the new investment instruments –Large leverage based on short-term borrowing Following the monetary policy tightening, the US housing bubble burst and the subprime crisis begun (summer of 2007). Key interest rates of major central banks Source: Central banks’ websites, Raiffeisen RESEARCH

3. Slide 3 / 28.04.2015 International crisis – effects worldwide Turmoil (turbulence) – financial crisis – economic crisis. Direct effects due to losses stemming from exposures in “toxic assets”. Major change in investors’ behaviour: increasing risk aversion; from global excess liquidity to liquidity crunch. Credit markets ceased to function as the confidence between the financial institutions and between banks decreased sharply. Turmoil in the financial market started to affect the real economy: many developed economies entered into recession. Central banks and governments worldwide reacted rapidly in order (1) to restore the confidence in the financial markets and (2) to limit the impact of crisis on the real economy –Ample injections of liquidity in the financial system from central banks (by extension of collateral and of credit terms) –Large cuts in the monetary policy rates –Deposit and interbank guarantees, and loans for financial institutions –Central banks and the governments took stakes in financial institutions (recapitalization through nationalization) –Anti-crisis packages are now in place in many countries

4. Slide 4 / 28.04.2015 International crisis – effects on Romania No direct effects of the subprime crisis on the Romanian economy –Banks in Romania had no direct exposure to the subprime market in the US, while mother banks abroad had also only a very low exposure to “toxic assets”. Important indirect effects because Romania is highly dependent on the external funding (current account deficit stood at 12.6% of GDP in 2008). External debt and the debt of banking sector (% of GDP, 2008 Q2) Current account deficit (% of GDP, 2008 Q2) Source: Eurostat, National Bank of Romania, Raiffeisen RESEARCH

5. Slide 5 / 28.04.2015 Romania – main challenges The crisis on the international markets and the large domestic macroeconomic disequilibria raise important challenges for the government and the central bank Challenges in short-term –Securing external financing –Securing stability of the financial system –Dealing with the downturn in the economic activity Challenges in long-term –Continuing the real and nominal convergence process in order to become a member of the Euro area –Securing sustainability of the current account deficit

6. Slide 6 / 28.04.2015 Romania – securing external financing (1) Romania was strongly affected by the increase in risk aversion due to large macroeconomic imbalances and inappropriate economic policies (i.e. proc-cyclical fiscal policy) –S&P and Fitch cut the country’s ratings to non-investment grade Availability of external funding decreased rapidly in the context of an ongoing process of international deleveraging –Foreign banks reduced additional funding to their local subsidiaries –FDIs inflows are likely to decrease in the next period –Foreign investors might decide to repatriate their profits Cost of external funds increased sharply Pressures for leu depreciation 5-years CDS for CEE countries Source: Bloomberg, Raiffeisen RESEARCH

7. Slide 7 / 28.04.2015 Romania – securing external financing (2) Current account deficit started to decrease, which means lower financing needs from abroad However, the current account deficit is still high and the short-term debt service is also important Romania could ask for financial help to the European Commission and the IMF. Current account and foreign trade balance Source: National Bank of Romania, Raiffeisen RESEARCH

8. Slide 8 / 28.04.2015 Romania – Securing stability of the financial system Stability of the exchange rate is a “vital” issue for the economy The leu was on a depreciating trend in last months, but the move was in line with developments in the other regional currency In order to limit leu depreciation, the central bank stepped in the FX market indirectly and had a strong control of RON liquidity in the market Regional exchange rates Fixed base index, 29 December 2007=100 Loans in foreign currencies (% of total) Source: Reuters, National Bank of Romania, Raiffeisen RESEARCH

9. Slide 9 / 28.04.2015 Romania – dealing with the downturn in the economic activity (1) Source: Eurostat, Raiffeisen RESEARCH Romanian economy expanded by more than 6% per year between 2001-2007 However, economic activity would decelerate rapidly in the next quarters (with important recession risk) –Recession from Euro area puts downward pressures on exports –Decrease in external funding limits capacity of banks to extend lending and of companies to invest  sharp deceleration of consumption and investments Average GDP growth rate in NMS (2001-2007 ) Real GDP growth (% yoy) Worst performers in industry at the end of 2008 (% yoy)

10. Slide 10 / 28.04.2015 Romania – dealing with the downturn in the economic activity (2) Source: Finance Ministry, Raiffeisen RESEARCH The large budget deficit (around 5% of GDP) and the downward pressures on the public revenues limit the capacity of government to expand public spending in order to offset the slowdown in private aggregate demand Financing a large budget deficit is also difficult (and costly) due to the financing constraint both on the local market and on the external markets This explains the lack of a strong anti-crisis package for the economy At the moment, the government should concentrate more on the increase of public spending efficiency and on the increase of structural funds absorption The government’s space of manoeuvre is limited The central bank’s space of manoeuvre is also limited Central bank remains focused on the exchange rate stability As a result, the stance of the monetary policy is likely to be eased only gradually. A more coherent macroeconomic policy mix (more restrictive Government policies) will reduce de monetary policy burden. Consolidated budget deficit (% of GDP)

11. Slide 11 / 28.04.2015 Romania – dealing with the downturn in the economic activity (3) There are some mitigating factors which might help the economy to avoid a hard landing in the next period: –Relatively lower share of credit in GDP; –The banking system is fundamentally sound and profitable; –Lower dependency on exports; –Exchange rate flexibility; –Large EU structural funds available for Romania. Exports of goods and services in 2007 (% of GDP) Non-government credit in 2007 (% of GDP) Source: Eurostat, ECB, Raiffeisen RESEARCH

12. Slide 12 / 28.04.2015 Romania – Appropriate measures required to support the real convergence process Long-run economic growth potential is strong given that GDP per capita is very low The government should avoid to pursue pro-cyclical fiscal policies and it should concentrate on investment expenditures (especially infrastructure) an absorption of structural funds; A more appropriate policy mix is required. GDP per capita at purchasing power parity in 2007 (% of EU 27) Note: The dark blue lines denote the value of the indicator in 2000 Source: Eurostat, Raiffeisen RESEARCH