Romania Commercial Banking Report Q3 2007

Economic Outlook While there are risks to Romania's outlook, it has a strong growth story. The country's gaping trade deficit is a sign of huge purchases of capital goods, which will in turn aid the export sector in years to come. BMI's recent in-depth investigation of our own bullish view on Romania was in response to the concerns of local analysts over the risks posed by the asymmetries within the economy. Although there are risks to our outlook - in particular from the political climate slowing down FDI inflows - we reiterate our upbeat stance on Romania and our RON3.0000/EUR target for the leu.

Another Strong Year For Investment Despite slightly lower-than-expected first quarter figures, our forecast for Romanian real GDP growth in 2007 remains a robust 6.5%. Private consumption will continue to drive growth, while double-digit expansion of investments can once more be expected. Average real GDP growth of 5.1% is expected over our five-year forecast period. However, the knock-on effect of above-trend expansion will be widening macroeconomic imbalances this year, predominantly as a result of huge import demand.

First quarter growth in Romania came in at a solid 6.0% y-o-y, well behind official and market estimates.

The most striking features of Q107 figures were strong private consumption expansion (11.3% y-o-y), massive gross capital formation growth of 17.2% y-o-y and a marked upturn in government consumption.

Despite double-digit growth of exports, the expansion of imports was almost double that figure, meaning net trade continued to be a significant drag on output. Both investment and private consumption look set to continue their stellar performances in 2007. Investment expanded by a massive 16.1% in 2006, led by foreign interest and reconstruction efforts after 2005's damaging floods. Record Q107 construction growth of 30.7% y-o-y attests to massive demand for new residential and commercial buildings, as well as huge and ongoing physical infrastructure projects. Romania's road infrastructure network is far behind average European standards and the government wants to see the construction of 240km of road every year for the next seven years, meaning the prospects for this sector look very healthy indeed.

Furthermore, investments have been flooding into the country in the wake of January's EU accession: 72% of the economy is now in the hands of the private sector, with the privatisation process picking up speed in recent years. The World Bank's 2007 Ease of Doing Business survey highlighted another reason for strong interest in the country: significant progress in areas such as building permits, labour market regulation and cross-border trading.

A number of factors are underscoring recent strong performance in private consumption. Domestic demand was the primary driver of growth across Central and Eastern Europe (CEE) last year. Wage growth in Romania, as in many other emerging European countries, is accelerating fast, as domestic firms compete to retain workers tempted by higher salaries in countries with semi-open labour markets such as Romania Commercial Banking Report Q3 2007 Business Monitor International Ltd Page 11 the UK and Ireland, as well as to open-door policy states in Central Europe. The European Commission expects both nominal and real 2008 wage growth in Romania to be the fastest among all 27 member states. Furthermore, strong growth is resulting in falling unemployment, with the headline rate at just 4.5% in April, down from 5.8% in April of the previous year. Expansionary fiscal policy, including government wage increases and upped social spending, will further boost consumer expenditure. The newly launched Property Fund, which will compensate citizens for assets confiscated under communist rule, will also result in large payments to affected individuals, and domestic interest rates look set to fall by at least a further 25 basis points (bps) to 7.00% this year, lowering the cost of borrowing across the board.

The Commercial Banking Sector The Romanian commercial banking sector is currently experiencing a period of strong growth, brought on in part by considerable overseas interest, which has led to the injection of foreign expertise and capital.

BMI is projecting continued growth. While this sector is growing from a very small (and underdeveloped) base by almost all standards, it seems clear that it is yet to reach its full potential.

Western banking groups are becoming increasingly dominant in the local financial system, and view their investments in (and loans to) Romanian subsidiaries as strategic positions in a country converging to the real GDP levels seen in the eurozone.

Of the 59 countries for which BMI collated data, the growth of Romania's banks in assets, loans and deposits were ranked at ninth, fourth and 12th, respectively. These rankings correspond to growth rates of 35%, 52% and 29% in these respective areas. The CEE region contains national banking sectors at both extremes of this growth spectrum, ranging from countries such as Russia and Ukraine, which are ranked among the top sectors in the world, to the middling to poor growth of Slovakia, Slovenia and Latvia.

Latest figures indicate that total assets, loans and deposits amounted to US$68.5bn, US$37.5bn and US$37.7bn, respectively. BMI has revised down its forecast for annual growth in deposits, from 30% to 25%.

Out of BMI's 59 county sample, Romania's loan/deposit, loan/asset and loan/GDP ratios were respectively ranked 22nd, 30th and 45th, which correspond to ratios of 99.5%, 54.8% and 30.8%. All three ratios are rising, and are reasonably middle-of-the-range rankings in a regional context.

Latest figures indicate that the bond portfolios of Romanian banks fell from an already low 2.0% of total assets in 2005 to 1.6% at the end of 2006. In dollar terms, though, the portfolio grew from US$800mn to US$1.1bn.

Press Reports Recent reports in the Romanian and international press generally reflect two issues: Firstly, there has been a string of positive profit and growth reports, reflecting the surging growth in the sector.

The second (and clearly related) factor has been the series of announcements in relation to the expansion of branch networks. There was a growth in the number of bank branches from 3,400 to 4.400 during 2006. Based on already announced plans that number will increase by at least 250 again in 2007.