Economy and Payments in Romania and Ukraine
Romania and the Ukraine are both rapidly developing their economies and financial services towards the goal of possible EU accession. Although the two countries are at different stages in their progress – accession is likely to be in 2007 for Romania, while Ukraine is not expected to join, if it joins at all, for at least another 10 years – both are showing determination in their approaches and are resolved to reform their economies quickly. Most changes in Romania’s financial services started 10-15 years ago as the country recovered from the Ceausescu regime. It has had time since then to develop its instruments and markets. Ukraine on the other hand is seeing a new lease of life with Viktor Yuschenko, the newly elected president, expected to liberalise the country’s economy and bring it further in line with the EU rather than adhering to Russia’s shadow. Whatever the differences in their stages of development, it is clear that these two countries hold lots of opportunities for foreign companies, with their skilled and low-cost work forces and outlook facing ever more towards Europe and less focused on their Russian neighbour.
Both countries have seen impressive economic growth rates since 1999 and the average GDP rate of growth for 2000 to 2004 was 5.2 per cent for Romania and 8.4 per cent for Ukraine, with GDP per capita now at US$3,367 and US$1,282 respectively (still far from the EU-25 average of US$27,300 per capita in 2004). Although GDP per capita is low, the two countries have large populations, which makes them an interesting market (the Ukraine has 47.6 million inhabitants and Romania has 21.7 million). Accession to the EU is providing a focus for the reform and restructuring within each country, and this is reducing the risk profile as each government concentrates on complying, in the end, with the Maastricht criteria (to limit government deficits, debt, inflation and interest rate differentials). Both countries are showing healthy development of the external debt figures. Romania has currently US$26bn-worth of external debt (25 per cent of GDP), which is expected to decrease to 21 per cent of GDP in 2007. Ukraine’s external debt of US$31bn (or 41 per cent of GDP) will decrease to 33 per cent of GDP in 2007.
In Romania the economic development was accompanied by a deteriorating trade and current account deficit. But the country saw a large inflow of foreign direct investment (FDI) and other private capital (for example portfolio investments) in 2004, compensating the current account deficit. The Romanian lei (ROL) has seen strong appreciation since November 2004 when the central bank confirmed its plans for capital account liberalisation and a more flexible exchange rate policy. The lei is expected to appreciate further because interest rates are not decreasing rapidly enough to discourage portfolio capital inflows. FDI is also driving an increase in productivity, which is helping to counterbalance the lei’s increasing value.
The Ukraine on the other hand has seen a high trade balance and a substantial current account surplus since 2002. However, the reason for these figures is not transparent and it is possible that import figures have been understated. Even so, selling metals to Russia is an important part of the Ukraine’s exports (35 per cent) and demand has been increasing in line with Russia’s rapid economic growth. Any slowdown in Russia would have a serious knock-on effect for Ukraine’s current account. The country’s currency, the hryvnia, is seen as undervalued because for many years the exchange rate policy was focused on the US dollar (90 per cent of Ukraine’s current account transactions were in US dollar). This year the hryvnia has started to appreciate. The discussion is taking place between the central bank and the government on whether the focus of the central bank policy should be on exchange rate targeting, or inflation targeting. So far the central bank will continue to focus on the exchange rate with the US dollar.
In the past both Romania and Ukraine have been neglected by foreign investors, but this has changed and in 2004 Romania saw several high profile deals, with foreign companies recently investing substantial amounts of money in the automotive sector. The low labour costs, compared to those of the Czech Republic or Hungary, are attracting production to Romania. The value of FDI into the country is thought to have doubled to US$5bn last year, while Ukraine could see its FDI inflow increase to US$2.5bn in 2005.
Romania has offered attractive incentives to some foreign investors, such as Sidex-Ispat and Renault Dacia. The government now wants to replace the individual incentives with an overall tax of 16 per cent on corporate profits and personal income. In the Ukraine similar plans are being discussed and these plans will lower the corporate tax to 25 per cent, and income tax rate to 13 per cent.
In both Romania and Ukraine, foreign companies are able to invest in local companies and acquire 100 per cent ownership of local enterprises – although they are not allowed to own land in the agricultural sector. In the Ukraine foreign companies must get approval from the anti-monopoly institute before any local corporate acquisition is made. Although privatisation was introduced many years ago in the Ukraine, due to a lack of foreign interest only a limited number of transactions have been completed. As a result, in many sectors of industry most of the companies are still government owned. With the new government in office introducing transparency in the privatisation process, a new wave of privatisation is expected.
In the Ukraine domestic payments can only be made in local currency unless it concerns payments for debts. The real-time gross settlement (RTGS) system in Ukraine, called System of Electronic Payments (SEP), which has been fully operational and online for several years, has made a substantial improvement in payment services. It is one of the most efficient systems in Eastern Europe and compares favourably with RTGS systems in western European countries as well. Ukraine skipped several steps in payments evolution when it went straight from the old paper-based system to RTGS. Domestic payments in the Ukraine follow the domestic messaging format. It is possible to use Edifact in both countries, but it is not common practice, and is not likely to be implemented in future. Edifact is in practice only relevant in cases where centralised corporate payments factories disburse payments for a group of countries, including Ukraine and Romania. The Edifact structure can contain all relevant information for payment instruction to afore-mentioned countries.
The Romanian payment system has so far shown major problems regarding electronic payment clearing (EPS). It has been very much paper based and has relied on manual processing, even more so than the Ukrainian payment system. The lack of an electronic payments system has made the inter-bank payments rather difficult, implying large commissions and only one clearing session per day. Domestic payments can currently take up to five working days. However, the Romanian central bank (The National Bank of Romania) has announced that in April 2005 an RTGS system will be introduced. RTGS is the first module of EPS and refers to the real-time clearing of high-value payments (over ROL500m) and urgent payments. The implementation of this system will lead to an increased efficiency by eliminating the current delays and the excessive transaction costs. The second EPS module, automated clearing house (ACH), will be introduced during May 2005 and will allow the clearing of low-value payments (below ROL500m) in one working day.
There are limited options for corporate treasurers to optimise their liquidity positions in Romania and Ukraine. At the moment in Romania only notional domestic cash pooling and zero balancing are available. The authorities in Romania and Ukraine view netting transactions, especially cross-border netting, as real transactions. Tax is therefore charged on netting, which makes them uneconomic activities. EU accession will require both countries to be more open and harmonisation of these restrictions is therefore only a matter of time. It is likely that tax on cross-border and domestic netting and pooling will be lifted in three to five years’ time in Ukraine, and Romania should introduce harmonisation sooner if it is to join the EU in 2007.
FX regulations in both countries are very restrictive. While foreign currency transactions for commercial purposes are allowed, proof of delivery of goods is necessary. Foreign currency transactions for non-commercial purposes, such as repatriation of cash, are not allowed. This causes considerable problems for corporates in these countries. Repatriation of cash via dividends is legally possible, but there are tax implications that companies need to be wary of. However, companies are pressing Ukraine’s new government to liberalise forex transactions. Up until now companies have been forced to transfer 50 per cent of their export proceeds into local currency.
One aspect of the financial environment in these two countries is that the Romanian government frequently used to act unilaterally without informing the corporate sector of new regulations or laws. Foreign investors were often taken by surprise by the new measures, but regular meetings between government officials and the association of foreign investors is helping to avoid these surprises for foreign investors. In Ukraine the new government is consulting the corporate sector before introducing new regulations and law proposals. This has certainly helped to improve the climate for foreign investors.
Although Romania and Ukraine have some way to go in bringing their cash management capabilities up to the standard that multi-national corporates are accustomed to, both are determined in their approach to reform and restructure quickly. The hryvnia and the lei are likely to appreciate, which will attract further foreign portfolio investment. Foreign companies are in favour of liberalising the FX regulations and this will also ease the financial environment. With both countries focused on harmonising with their EU neighbours, further reform will not be far away.