FDI Inflows in Romania

Mihai Copaciu

CEROPE

Bucharest, May 10, 2011

Preliminary Draft – For discussion only

Aims of the paper

1. Overall FDI

trends

1.1. Size and

structure of the

stock

1.2.FDI&Foreign

trade&labour

costs

3. Determine the

main effects of FDI

firms on the domestic

economy

– micro data (to be

completed)

4. A set of policy recommendations

2. Identify the main

determinants of FDI

inflows 2.1. macro data

(EU10)

2.2. impact of institutional

variables

1.Overall FDI trends

1.1. Size and structure of the

stock

1.2.FDI & Foreign trade &

labor costs

1.Overall FDI trends• Increasing FDI inflows starting with 2004

– (Expectation of) EU membership;

– International context characterized by abundant liquidity and a

relatively low degree of risk aversion;

– But still faster increase in the current account, the latter financed

increasingly through (short term) debt creating inflows.

• Significant adjustment in FDI inflows after the beginning of

the crisis

– Increased risk aversion;

– Increased probability of capital outflows => agreement with IFIs;

– Current account deficit adjusted significantly reflecting the drop in

both internal and external demand.

FDI stock per capita (euro) – 2009

8418.4

8088.7

6814.1

6743.6

5147.9

4678.9

3547.0

3379.9

2922.3

2322.5

0 1000 2000 3000 4000 5000 6000 7000 8000 9000

Estonia

Czech Republic

Hungary

Slovakia

Slovenia

Bulgaria

Latvia

Poland

Lithuania

Romania

Source: Eurostat, own calculations

1.1.Lowest FDI stock in per capita terms

EU10-Structure of the inward FDI stock (% of GDP, 2009)

0

10

20

30

40

50

60

70

80

90

100

Bulgaria* Czech

Republic*

Estonia* Hungary* Lithuania Latvia Poland Romania Slovenia Slovakia*

Not allocated

Services

Constructions and Energy

Manufacturing

Agriculture and Mining

Source: Eurostat ; *- latest data available for 2008

1.1.EU10: Structure of the FDI stock to GDP ratio

1.1.Romania: structure of the FDI stock to GDP ratio

Romania-Structure of the inward FDI stock (% of GDP, 2003-2009)

0.2 2.2 2.1 2.3 1.9 1.7 2.39.4

11.3 10.2 12.0 11.3 10.913.80.5

0.4 1.41.8 1.7 3.2

3.58.3

10.8 13.7

19.1 19.5 18.8

23.5

0

5

10

15

20

25

30

35

40

45

2003 2004 2005 2006 2007 2008 2009

Agriculture and Mining Manufacturing

Constructions and Energy Services

Source: Eurostat

Structure of the inward FDI stock in manufacturing (% of GDP, 2009)

0

1

2

3

4

5

6

7

Food products Total textiles

and w ood

activities

Total

petroleum,

chemical,

rubber, plastic

products

Total metal and

mechanical

products

Total off ice

machinery,

computers,

RTV, comm.

eq.

Manufacture

of medical,

precision and

optical instr.,

w atches

Total vehicles

and other

transport

equipment

Miscellaneous

manufacturing

Bulgaria:15.1%Czech Rep.:19.1%Estonia:10.0%Latvia: 5.0%Lithuania:10.1%Hungary:16.3%Poland:13.2%Romania:13.8%Slovenia:7.4%Slovakia:20.7%

Source: Eurostat , *- latest data available for 2008

1.1. Manufacturing oriented FDI – most of

them resource and efficiency seeking

Structure of the inward FDI stock in services (% of GDP, 2009)

0

5

10

15

20

25

30

Trade and

repairs

Hotels and

restaurants

Transport and

storage

Post and

telecom

Financial

intermediation

Business

activities

Real estate Other

services

Bulgaria:62.5%

Czech Rep.: 29.6%

Estonia:53.9%

Latvia:32.1%

Lithuania:21.9%

Hungary:37.5%

Poland:24.2%

Romania:23.5%

Slovenia:20.8%

Slovacia:27.8%

Source: Eurostat , *- latest data available for 2008

1.1. Services oriented FDI – mostly market

seeking

Romania – export and import activity of FDI firms in 2009

Exports (FOB) Imports (CIF)

mil.

euro

% of total

sector

mil.

euro

% of total

sector

Total economy 19643 69.8 22525 60.1

Industry, of

which:

17264 79.3 15155 76.5

Manufacturing 16440 79.7 14423 78.8

Trade 1827 51.7 6214 45.4

Other activities 552 19.7 1156 29.0 Source: NBR, NSI (Foreign Direct Investments in Romania in 2009)

1.2. FDI firms make most of Romania’s

external trade

1.2. In 2010 Romania had among the EU10 countries the

highest exports’ level relative to the maximum reached in

2008

EU10 - 2010 exports/imports as a share of 2008 exports/imports (%)

0 20 40 60 80 100 120

Bulgaria

Czech Rep.

Estonia

Latvia

Lithuania

Hungary

Poland

Romania

Slovakia

Slovenia

Exports

Imports

Source: Eurostat , own calculations

1.2. Increasing share of higher added value

exports

High technology exports* as a share of manufactured exports (%)

0

5

10

15

20

25

30

35

40

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Euro area European Union Bulgaria

Czech Republic Estonia Hungary

Latvia Lithuania Poland

Romania Slovak Republic Slovenia

Source: World Bank , * High-technology exports are products with high R&D intensity, such as in

aerospace, computers, pharmaceuticals, scientific instruments, and electrical machinery.

1.2. Significant comparative advantage in

terms of relative costs

Hourly labor costs (euro)

0

5

10

15

20

25

30

35

40

45

Business economy Manufacturing Electricity, gas,

steam and air

conditioning supply

Construction Services*

EU27 Euro area 16 Bulgaria

Czech Rep. Estonia Latvia

Lithuania Hungary Poland

Romania Slovenia Slovakia

Source: Eurostat, Labor Force Survey 2008. *- Services except public administration, defense, compulsory

social security, activities of households as employers and extra-territorial organizations and bodies.

1. FDI in Romania – main features

• FDI in manufacturing (stock of 13.8% of GDP in 2009):– Resource and efficiency seeking;

– Mostly vertical nature;

– FDI firms make most of Romania’s foreign trade;

– Still relatively low, but increasing share of higher value added exports in total external trade.

• FDI in services (stock of 23.5% of GDP in 2009):– Mostly market seeking;

– Both vertical and horizontal nature.

• FDI in agriculture and mining – very small

• In terms of labor costs Romania still has a significant comparative advantage relative to the other EU10 countries (except Bulgaria), EU and EA16.

2. EU10: main determinants of

FDI inflows

2.1. Macro data

2.2. Impact of institutional

variables

2. EU10 – Main determinants of FDI inflows

• EU10 panel regressions

• The same methodology as Walsh and Yu (2010)

– besides total FDI determinants, trying to see if they differ whether

the FDI flows into the tradable or non-tradable sectors:

• Tradable sector FDI: agriculture+minning+manufacturing;

• Non-tradable sector FDI: constructions+energy+services;

– Checking the relevance (one by one) of institutional variables;

Data sources: Eurostat (FDI and sectoral data), WDI, EBRD and

Transparency International (for institutional variables).

2.1. Aggregate FDI inflows –

macroeconomic determinants

Higher FDI inflows result from:

• an increase in the

openness degree of the

economy

• lower relative costs (REER

depreciation in real terms)

• higher GDP growth

• Lower GDP/capita at PPS

Variables Total FDI inflows/GDP

Openness 0.118***

(0.035)

REER -0.163*

(0.093)

Inflation -0.018

(0.085)

FDI stock lagged 0.000

(0.000)

GDP growth 0.175**

(0.076)

GDP per capita at PPS -0.126***

(0.043)

Sargan p-value 0.572

Standard errors in parentheses. A decrease/increase

in REER means a depreciation/appreciation in real

terms of the domestic currency.

* p<0.10, ** p<0.05, *** p<0.01

2.1. Tradable sector oriented FDI –

macroeconomic determinants

Higher FDI inflows in

the tradable sector

result from:

• an increase in the

openness degree of

the economy

• lower relative costs

(REER depreciation in

real terms)

Variables

FDI inflows/GDP in the

tradable sector

Openness 0.027**

(0.013)

REER -0.073*

(0.040)

Inflation 0.062

(0.065)

FDI stock lagged 0.000

(0.000)

GDP growth 0.008

(0.030)

GDP per capita at PPS -0.023

(0.019)

Sargan p-value 0.377

Standard errors in parentheses. A decrease/increase in

REER means a depreciation/appreciation in real terms of

the domestic currency.

* p<0.10, ** p<0.05, *** p<0.01

2.1. Non-tradable sector oriented FDI –

macroeconomic determinants

Higher FDI inflows in

the non-tradable

sector result from:

• higher GDP

growth (higher

growth potential of

the domestic

market).

Variables

FDI inflows/GDP in the

nontradable sector

Openness 0.026

(0.046)

REER 0.083

(0.132)

Inflation 0.178

(0.271)

FDI stock lagged 0.000

(0.001)

GDP growth 0.172*

(0.094)

GDP per capita at PPS -0.086

(0.069)

Sargan p-value 0.546

Standard errors in parentheses. A decrease/increase

in REER means a depreciation/appreciation in real

terms of the domestic currency.

* p<0.10, ** p<0.05, *** p<0.01

2.2. EU10:The impact of institutional variables

• Mixed results regarding the impact of education (primary, secondary and tertiary enrollment) on FDI inflows.

• Privatization of the state owned system increases FDI inflows, both in the tradable and non-tradable sector.

• Better governance and enterprise restructuring have also a positive impact on FDI inflows, both in the tradable and non-tradable sectors.

• Banking reform and interest rate liberalization has a positive impact on FDI in the tradable sector.

2.2. EU10:The impact of institutional variables

• No impact of perceived level of corruption on FDI inflows.

• An improved competition policy leads to higher FDI inflows especially in the tradable sector.

• Better roads and railways infrastructure lead to

higher FDI in the tradable sector.

• Improved telecommunications and railways

infrastructures positively affect the FDI inflows in

the non-tradable sector.

4.Romania: policy recommendations

4. Increasing role for the institutional

factors• Foster the openness of the economy and thus

strengthen the real convergence process– The openness degree of the Romanian economy is still

rather low compared to the other EU10 countries.

• Encourage investments in the more capital intensive sectors (vertical spillovers)– Labor costs gap expected to diminish throughout the

real converge process, with some of the FDI relocating towards lower labor costs regions (e.g. textiles).

– Market specific and institutional factors will be more important in an economy’s whose competitiveness is increasingly based on more capital intensive goods.

4.Privatization

• Restructuring the still state owned

enterprises is a must.

• Choose between further privatization,

preferable in a high transparency way, or

assure competitive governance for these

firms.

– The latter can be seen also an intermediate

step towards privatization, aiming at improving

the performance of state-owned firms.

4.Corporate governance and

enterprise restructuring

• Although a governance code exists for the listed

companies, Romania ranked at the end of 2010

lowest among EU10 countries for this indicator.

• The initiative of AmCham to adopt a code of

corporate governance code for its members is an

example for authorities to extend such a code

economy wide. This will enhance long term capital

investments, both domestic and foreign.

4.Competition policy

– Among EU10 countries, Romania ranked last at

the end of 2010.

– Positive developments especially in terms of

legislation.

– Further steps:

• Unrestricted entry should go together with an

efficient monitoring from the competent authorities.

• Competition Council - adding human resources with

skills in law and quantitative analysis to the already

existing one should become a priority.

4.Infrastructure

– The low quality of infrastructure has been

continuously mentioned as a drawback for

Romania in attracting more FDI.

– Give full priority to projects aimed at improving

the existing infrastructure or developing new

one.

– As a support for these actions, increasing the

absorption capacity of EU funds should receive

an at least equal attention.

4.Corruption

– For EU10 estimations do not show a significant

impact of perceived corruption level on FDI

inflows.

– For Romania it has been also frequently

mentioned by foreign investors as an obstacle

for higher FDI inflows in Romania.

– Although progress has been made, increasing

further the efficiency and the accountability of

the judicial system is a must.

4. Time consistency

• Do not obstruct the business environment by

increased volatility induced by political tensions,

frequent changes in the legislation, fiscal one

included.

• A time consistent policy, “say what you do and do

what you say” type is the primary condition that

should be respected in order not only to facilitate

more FDI inflows, but also to ensure a smooth

functioning of the economy as a whole.