Matei Paun, in Bucharest, discusses what it will take to increase foreign investment in Romania, and recommends some policy initiatives.

There is no single recipe for success. Yet there are some general lessons to be learned from, and applied to, Romania’s decade-long drive to attract foreign investors, be they portfolio or direct investors.

Many will focus on laws, regulations and corporate governance as the list of preconditions for investment. Others will concentrate on political stability and democratic norms. Still others will seek out cultural, historical and geographical ties in justifying investments or the lack of them. But the biggest reason why investors of any kind will risk their capital is healthy and promising economics.

Regulation

Laws are important. Specifically, their consistent and thorough enforcement is always helpful. Yet whether they are applied at all rests on the judiciary’s or regulator’s objectivity. And, in turn, that objectivity can exist only within a certain degree of material well-being. This rests on sound economics, which is the biggest weapon against corruption.

Many might argue that sound laws and regulations create the preconditions for economic growth. They do not. In this case, it is the chicken that must come before the egg. Even with the most admirable laws, hyperinflation and current account deficits cannot be banished through legislation. Laws will not give you high earnings multiples or positive EBITDAs (earnings before interest, taxes, depreciation and amortisation).

Solid purchasing power is worth all the commercial codes in the world. Entrepreneurship and capitalism are at their most natural in lawless environments. No-one is advocating legal anarchy as a first step towards economic growth – ideally, both would develop in parallel – but politicians often spend too much time trying to legislate growth through a cadre of laws.

It is probable that if Romania’s inflation was in single digits, its state-owned companies privatised and the trade deficit balanced, the question of foreign investors would have been resolved many years ago.

Expecting a profit

Investors want to put their money in businesses that will return them a profit, if not immediately then at least in due course. This most often means either investing in firms that sell a product or service profitably domestically or a company that exports competitively. The richer a domestic market is, the more likely a business can make money by supplying it with goods or services. This inevitably means the taming of inflation, which is the single biggest destructor of domestic wealth. And, ultimately, this means sound economic growth that, in turn, can be built only on solid macroeconomic stability.

The same is largely true for exports. Maintaining a country’s competitiveness is largely the result of a stable and favourable macroeconomic environment, which keeps and sharpens a particular nation’s edge. Investments in productivity, an appropriate exchange rate and a competitive fiscal regime are all based on a sound macro base.

Gradualist approach

Romanian politicians often wonder why their country is near the bottom of the list in terms of foreign direct investment, GDP per capita and inflation. The answer lies in the decade of boom-and-bust cycles that have plagued Romania. Greed, fear, self-interest, hesitation and incompetence have all led to a gradualist approach towards economic reform.

A generally fenced-off domestic capital account, a lack of foreign debt immediately after 1989 and nimble footwork have given Romania an uncanny – and unfortunate – ability to ride out recurring boom-and-bust cycles. This is what has kept foreign investments to such a low level.

It is a commonly-held belief among Romania’s cadre of policy makers and economists that regulating (that is, preventing) foreign capital flows has made all the difference between Romania and the Bulgarian, Russian and, more recently, Argentine experiences. But capital flows should only be feared by those who fear their own ability to behave competently.

Hard lessons

It could be argued that the crises in Bulgaria (1996) and Russia (1998) have played a critical role in firmly setting both countries on the path to sustainable, sound economic growth. Once faced with the full effects of economic failure, there is no other choice but to opt for the road to reform. Also, the experience clearly articulates the merits of reform to a shell-shocked population.

Romania has made some progress. Inflation and interest rates have fallen. The external debt is relatively low. The banking sector has been largely reformed and privatised. Yet this is outweighed by the fact that inflation and interest rates are still some of the highest in Europe. Inter-company arrears, particularly linked to the energy utilities, account for more than 50% of GDP and threaten to become the government’s latest subsidy vehicle. The trade deficit is rising sharply, putting the National Bank in a difficult position. GDP growth is under pressure, not only from external factors but from domestic considerations as well. And FDI is still low.

Romania needs to cut spending to bring down interest rates and inflation. It should open up financially to capital flows and assume the risks that entails. It needs to sell off its remaining companies before they lose what value they still hold, and to close what cannot be sold or given away. It must collect taxes more efficiently and stop the annual ritual of a tax amnesty, which only increases the moral hazards associated with such practices. It needs to reform and consolidate the fragmented and inefficient agricultural sector, which accounts for a large chunk of GDP. And it needs to tighten the self-imposed deadlines and targets it has given itself. Why wait until 2003 or 2004 to sell off the largest bank in Romania or the state oil company? Why drag out the long awaited single-digit inflation targets until 2004 and beyond?

Difficulties lie ahead

Romania’s economy faces no immediate dangers. It can maintain its present course, quite likely, through 2003. However, on present trends, 2004 looks to be a difficult year. Being an election year, it is likely that everything will be done to postpone a crisis until 2005 and so, in effect, accentuate it.

To tempt foreign investors, Romania’s policy makers need to eliminate the conditions that give rise to such potentially negative scenarios.

Romania is not special – no country is. Its policy makers need to understand that it will succeed in courting foreign capital only through aggressive, decisive and sustained bouts of economic reform. Erring on the wrong side of prudence will perpetuate the country’s boom-and-bust cycle.

Investors always have a choice. Romania does not.

Matei Paun is a partner in HTI Group, a Romanian brokerage and financial advisory group.