COMMENT: Romania's questionable new bank tax follows Hungary and Austria's footsteps

COMMENT: Romania's questionable new bank tax follows Hungary and Austria's footsteps
Romania's new bank tax copies those of Hungary and Austria but carries more risks
By Gunter Deuber of Raiffeisen Research in Vienna January 7, 2019

The mood in Western Europe regarding Romania is currently not very positive. This applies to the public and private sectors - and the two are intertwined.

Some prominent public figures -- most prominently EU Commission President Jean-Claude Juncker -- see Romania as undeserving to hold the current EU Presidency, which Bucharest took over on January 1 for the first time since joining the EU. (Some politically overly correct observers might have thought the same thing about the previous EU Presidency being held by Austria.)

But in the private sector in Western Europe, the most recent ad hoc fiscal manoeuvres in Romania have caused astonishment and even annoyance, depending on the degree of concern. Particularly hard hit by recent special tax manoeuvres were certain sectors with a relatively high proportion of foreign investors, or those that are rather immobile, such as the banking sector.

Romania is following in the footsteps of both Hungary and partially Austria in this respect in several ways. Both countries introduced hefty special banking taxes in 2010 and 2011. In Hungary, special taxes were also introduced for similar other sectors as in Romania. And at the political level, all three countries are currently less than the cute children of Western Europe, but instead prone to temper tantrums, naughty behaviour and screaming sessions.

But let’s turn now to the economy and bank taxation. In Romania’s case the overall constellation is much more questionable than in Hungary or Austria. On the one hand, Romania - in contrast to Hungary and Austria - has not experienced a massive or systemic banking crisis in the last ten years, whereas both Hungary and Austria went through bank crises in 2008.

According to relevant data and criteria, the last massive or systemic banking crisis in Romania dates back to 1998. Of course, following the high credit growth from 2000 to 2008, there was a massive increase in non-performing loans (NLPs) in Romania. In 2013/2014, Romania had one of the highest ratios of non-performing loans in Central and Southeastern Europe and the whole EU with approx. 20%. However, this mountain of non-performing loans was then restructured and written off without state financial support - which in part led to massive losses in the banking sector.

The largely foreign-owned banking sector had to digest four loss-making years (2010, 2011, 2012 and 2014), while even the difficult Hungarian banking sector was “only” loss-making for three years (2011, 2012 and 2014). Therefore, foreign investors “contributed” a lot to the banking sector clean-up, while no government intervention was needed; like in some other countries that introduced a banking taxation in the past. In terms of number of loss-making years (over the last decade) only the Ukrainian banking sector fares worse than the Romanian one in the broader region!

After years of deleveraging, NPL reduction and partly lean profits, the Romanian banking sector was just well positioned to enhance its buffers and to finance future growth based on the decent 2016-2018 performance.

We should not neglect the fact that the total capital adequacy is not very spectacular vis-à-vis SEE EU peers (e.g. Bulgaria, Croatia). Moreover, the current solid profitability in the Romanian banking sector comes at a very special point in time with regards to the NPL cycle and cannot be extrapolated. Although the “oversized” profitability of the Romanian banking sector has been addressed in the domestic public discussion recently, we see no evidence of such an excessive profitability from a regional CE/SEE perspective (not a general EU perspective, where profitability is much lower than in CE/SEE).

In itself, Romania's banking sector is not so profitable from a long-term and strategic investor point of view. From 2000 to 2017, the Romanian banking sector's return on equity in 12 years was below the average in Central and Southeastern Europe and above it for in only 6 years.

Also in terms of profit in relation to assets Romania does not look much better. Here the banking sector in the country performed eight times worse than the regional average and only 10 times better. Here it is true that the profitable years hardly compensated for the years of below-average profitability, with massive losses in some cases. From 2010-2015 the average annual return on equity stands at -5.4%, while we have seen less years with decent returns from 2016 to now. 

In addition, the design of bank taxation has some questionable elements. Firstly, pro-cyclicality - given the current high spending propensity of the government - can be increased in an already volatile economy. This is because the government will have more revenue at its disposal if the key interest rate rises, i.e. if inflationary pressures increase. In case of negative growth effects resulting from recent fiscal and tax manoeuvre stagflation risks are definitely on the rise in the Romanian economy.

Secondly, the implementation of monetary policy can be made more difficult. And here it is true that the central bank is one of the institutions with the highest credibility in the country.

Thirdly, the level of taxation or the respective reference rates have been chosen in such a way that the intention to generate revenue becomes obvious. Money market rates at around 2% should be seen as being below a “neutral” level of interest rates in a “catching-up” economy like Romania.

Finally, the linkage between domestic interest rates and the level of banking taxation seems somewhat strange given the high level of euroisation in the banking sector and huge discrepancies between domestic and foreign interest rates.

Besides the negative immediate impact on the banking sector one should not underestimate the broader impact given the uncoordinated way how ad hoc fiscal policy adaptions have been implemented. The overall degree of political predictability is definitely declining. In this context it is worth mentioning that the National Bank of Romania (BNR) is also taking a rather critical view of the special banking taxation and its design. Several BNR representatives clearly stated that they were not able to make a proper impact assessment due to the uncoordinated way recent legislative changes have been introduced. Secondly, there is a clear return to pro-cyclical fiscal policies  and traditionally serious economic policy is disorientated in Romania.

Despite all the problems, Romania does not seem to be afraid of the adverse macroeconomic effects of bank taxation and other special taxes. Perhaps Hungary serves as a shining example here. In Hungary, in view of the return to solid growth performance since 2013/2014, there are hardly any adverse long-term effects to be seen from the temporarily high special taxation. However, hefty bank taxation in Hungary (and also in Austria) was reduced after a few years in 2015/2016 (and 2017 in the case of Austria) due to adverse effects. Moreover, it should also be emphasised that Hungary had a completely different starting point in economic terms and in terms of it overall degree of international integration. Therefore, agglomeration effects and path dependencies are possibly much higher here than in case of Romania.

The stock of foreign direct investments (in % of GDP) and foreign trade in relation to GDP is much more pronounced in Hungary. Therefore, there are possibly more incentives to dive through adverse phases than is the case in Romania. In addition, the share of foreigners in the banking market in Romania - despite a certain decline in the last 1-2 years - at almost 80% is still 15 to 20 percentage points higher than in Hungary (OTP Bank calculated) at the time of high bank taxation. Furthermore, the Romanian economy relies much more on domestic demand, partially credit-driven, than Hungary back a few years ago. The banking sector in Romania - after years of debt relief - would be in need of growth right now; in Hungary, bank taxation went hand in hand with a phase in which, also from a fundamental perspective, little growth of the balance sheet total in the banking sector was indicated. Moreover, there are fewer financing alternatives in Romania. All in all, the negative (growth) effects of the hefty bank taxation in Romania could be more significant.

Currently, it is difficult to say how long it will take for a rethink to take place in Romania. Practical experience in Central Europe (including Hungary and Austria) rather teaches that one should reckon with several years of existence of a special tax (once introduced), i.e. at least 3-5 years or even 7 years. Moreover, it is worth mentioning that the current round of economic populism in Romania has appeared during a phase of still very good economic data. And normally populism risks rise in phases of weak economic development. So the question remains whether things need to get worse before they get better in a few years' time.