ROMANIAN CASE STUDY
1.3. EXISTING LEGAL FRAMEWORK FOR THE FINANCIAL MARKET
of affairs seems to lie more with weaknesses in policy making and implementation.
It is time to recognise that overall government policy, including the SME policy, has been characterised by insufficient coherence, credibility and transparency6. It has been difficult to feel confident in the coherence and completeness of national SME policy.
The OECD country survey of 1998, includes the following statement:
Because most of the restructuring problems are related to the existing large industrial companies, the governmental policy has, so far, concentrated on them. Some of the governments efforts should be devoted from now on to the promotion of entrepreneurship and development of a new private sector7.
From the point of view of the legal background, the points of concern are:
- lack of stable & coherent legal framework,
- need to improve enforcement of laws relating to SMEs,
- the level of bureaucracy and administrative burden/constraints,
- need for a standing monitoring & review mechanism on legal matters, and - a need for a consultation and advocacy function or mechanism.
1.3. EXISTING LEGAL FRAMEWORK FOR THE
The legal base for guarantee funds is established by GO 23/1999 on the incorporation of guarantee funds. Thus, in order to support small and medium-sized enterprises, guarantee funds may be set up with the exclusive aim of guaranteeing part of the credits or other financing instruments that may be obtained from commercial banks or other sources. The law provides the possibility of setting up mutual credit guarantee consortia as associations without legal personality, through a private company contract among more parties.
The main business of co-guarantee funds is granting guarantees, in full or partly, for the operations of a guarantee fund. They are organised as joint- stock companies, by associations of traders, natural or legal persons, aiming at reducing financial risks or lessening the damages, which could arise from guarantee funds operations.
The Ministry for SMEs is currently working on a draft law for establishing the National Fund for Guaranteeing Credits for SMEs, for which the state budget has already earmarked ROL 50 billion and which will facilitate access to bank credits for SMEs. At present, the value of credit collaterals varies from 130 to 175% of the value of the credit. The Fund will guarantee up to 75% of the credit value.
Banks wishing to operate guarantee funds in favour of SMEs benefit from Art. 89 of the Bank Law.
Regulations on the securities market have been issued by the National Commission on Securities and have covered: authorisation and security intermediation (Order 3/1998), computerised transmission of documents (Order 5/1998), supervisory reports on the capital markets (Order 17/1998), creation and organisation of capital market for non-listed securities (Decision 540/1999, Order 4/1999), procedural regulations of the Arbitration Chamber of the Stock Exchange and RASDAQ.
Overall, Romanian legislation covers the requirements, but has been highly unstable, complicated and sometimes some legal regulations contradicting other ones. There is a need now for simplification and elimination of inconsistencies, as well as of further harmonization with European legislation.
2. CURRENT STATUS OF SME FINANCING
One of the most important problems, that SMEs in the Romanian economy face, is access to financing, a problem, closely linked to their other problems like obsolete equipment, high taxes (including wage taxes) and the legal requirement for paying VAT at the moment of invoicing. Romanian companies are frustrated by the awareness that their products are not internationally competitive. They believe this to be caused by lack of modern equipment and reduced access to technology. This, in turn, is in part due to difficult access to investment finance. The cost of finance in Romania is prohibitive, with a considerable impact on the profit and loss account and thence the balance sheets. Projects would need to show a very high rate of return in order to cover an interest rate on loan that is, at present, around 15% annually on hard currency loans and 65% - on local currency loans.
An important part of exports are carried out in the OPT system due among others to lack of financing required for producing for export.
Inter-enterprise arrears are still a disease of the Romanian economy and have reached in 1999 ROL 226,145 billion, or 43.3% of GDP, on the increase from the 36.1% of GDP in 1998. Due to unsold production, high inflation and high interest rates, economic operators resorted to arrears in payment to suppliers or/and public budgets to cover 71% of attracted financial resources.
In a study carried out by the Romanian Center for SMEs regarding their financial requirements, their main sources of finance are their own capital, supplier credits and bank credits. Besides those there are also credits from international programs, grants from international programs, leasing, subsidies, factoring.
2.1. EXISTING FINANCIAL INSTRUMENTS
There are several financial instruments already in use in Romania. The most widespread is bank credits, but in recent years other instruments started to be used, like leasing, factoring and others.
In a recent survey8, at the question regarding the top five difficulties encountered by SMEs, difficult access to credit held fifth place (other were high wage taxes, number and level of taxes, high profit taxes, payment of VAT at the issue of the invoice).
One can note that while the SME sector held in 1999 a share of 44.9% in total turnover and of 40.2% in total number of employees, its share in total loans to commercial companies was of only 30.9%. This may be linked to the lack of acceptable collateral, as well as to reticence in entering into debt, as interest rates were not only high, but also extremely volatile in the high-inflationary environment that characterised Romania during the transition years.
8 Revista IMM, no 20 (March-April 2001)
Bank credit
While bank credits are a widely used financing instrument, high and unpredictable inflation and high collateral requirements limit their use.
Table 6 Share of the SME sector in total loans to commercial companies with reported balance sheet
Source: ANDR The private sector of small and medium-sized enterprises in Romania, Report, Nov. 2000
1997 1998 1999
Industry, out of which: 17.9 % 17.5 % 20.7 %
- textiles, leather and footwear 10.2 % 12.7 % 20.8 %
- food 40.0 % 40.2 % 36.9 %
- pulp and paper 43.0 % 63.2 % 69.1 %
- metal construction and products 21.8 % 32.1 % 39.0 % - other industrial activities 10.1 % 9.5 % 13.4 %
Agriculture 40.8 % 41.7 % 63.6 %
Construction 61.6 % 45.5 % 62.2 %
Trade 51.9 % 66.0 % 69.9 %
Tourism 56.6 % 46.2 % 15.3 %
Transport 12.7 % 10.6 % 9.3 %
Services 16.8 % 28.2 % 33.3 %
SME sector 29.6% 28.6 % 30.9 %
Table7 Distribution of total loans to the SME sector by size categories
Source: ANDR The private sector of small and medium-sized enterprises in Romania, Report, Nov. 2000
Private State-owned Mixed
1997 1998 1999 1997 1998 1999 1997 1998 1999 Micro 32.0% 38.5% 34.4% 7.7% 5.9% 4.4% 2.8% 3.4% 4.2%
Small 35.0% 31.8% 32.1% 18.0% 31.7% 31.6% 13.1% 15.8% 24.8%
Medium 33.0% 29.7% 33.5% 74.3% 62.4% 64.0% 84.1% 80.8% 71.0%
Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
a) Foreign financing lines carried out through Romanian banks;
b) Financing programs from own funds of Romanian banks;
c) Other programs.
a) Foreign financing lines carried out through Romanian banks
There are several foreign financing lines carried out in Romania through various Romanian banks.
PHARE scheme
Since June 1999, three Romanian banks (CEC, Banca Romaneasca, Banca Comerciala Ion Tiriac) opened credit lines exclusively dedicated to SMEs with the support of the European Union that allocated to this sector the amount of EURO 5.75 million. PHARE credits for SMEs are granted over a period of 1 to 6 years and cover a maximum of 85% of the investment, the rest to be covered by the firm. Payment is done in quarterly instalments, after a grace period (3, 6, 12 months). Interest is set according to market rates and to the stipulations of the loan agreement. The credits are for tangible investments required for the modernization and development of existing manufacturing companies or for the establishing of new companies.
EBRD credits
EBRD signed in December 1999 an agreement with Banca Transilvania for the granting of short and medium-term credits to SMEs. Credit beneficiaries are to be Romanian private companies with up to 100 employees. Credit destination: investment projects, working capital, trade financing.
KfW financing line
Kreditanstalt fur Wiederaufbau (KfW), Germany has concluded loan agreement both with CEC, as well as with Eximbank. The first is for firms with up to 50 employees and has an upper limit of DM 100,000 for a period up to 2 years and an interest rate of 12-16% for credits in DM. The latter is for private companies with up to 250 employees. The credit upper limit is of DM 1 million over a period of 3 years.
RAEF small and medium-size loans
The Program for small and medium-size loans of the Romanian American Enterprise Fund is unfolded through Banca Romaneasca. The credit range is of USD 20,000-150,000, over a period of maximum 3 years and an annual interest rate of 15% payable in monthly instalments. Eligible are SMEs with less than 200 employees.
The private sector complains that the interest rates on credits remain very high;especially as for foreign credit lines there are many Romanian intermediaries (banks) that add their own margins and increase the cost of loans.
b) Financing programs from own funds of Romanian banks
CEC (former Savings Bank) offers short-, medium- and long-term credits to SMEs for credit lines, financing of stocks, operating capital and for equipment Special Loan
Programmes
(up to 85% of the investment value). CEC has participated in the tender organised by the Ministry of Labour and Social Protection regarding the unfolding of the SME financing line. It has also taken steps towards obtaining PHARE funds for operating and financial credits.
c) Other programs
• Industrial Restructuring and Professional Redeployment Program (RICOP), launched by the European Commission with the desire to help solve unemployment-linked problems. Within its five main components, RICOP has a SME financing component, which will be targeted towards job creation in 17 counties most affected by economic reform and involves a total financing of EURO 48 million.
• Mining Affected Regions Restructuring Fund Program (MARR) is a program financed by the PHARE program and is aimed at SMEs from the counties of Gorj and Hunedoara, affected by the mining restructuring program. The loans are for up to EURO 300,000. Eligible costs are mainly for tangible investments for the development and modernisation of existing or new enterprises.
• Cooperative Housing Foundation micro-credit program. This program targets for the moment the counties of Timis, Caras-Severin and Mehedinti and is financed by USAID. The loans granted are up to USD 20,000 with a repayment period of maximum 24 months. The specificity of this program is given by the fact that the amounts are given through associations to their members, on a revolving-type base. The program has been a success.
• Program of the National Agency for SMEs to support SMES in their marketing and exports.
• Women Into the New Network for Entrepreneurial Reinforcement project (WINNER), launched by DEVNET TIPS (international network for the promotion of business opportunities) and UNITEM (the UN Development Fund for Women). The program is designed as a pilot program for the support of women entrepreneurs and women managers from SMEs, support for their participation to new information and communication technologies (ICT) and e-trade;
• ECOLINKS and CEEBIC programs were initiated by the US Embassy in Bucharest and are financed by USAID. ECOLINKS offers to SMEs loans for financing feasibility studies and pilot-projects in the environmental field, while the CEEBIC program aims to supports trade links between SMEs from CEECs and those from the United States.
Venture capital is regulated by Government Ordinance of January 30, 1998.
Here are a number of venture capital funds operating in Romania, the most important being the Romanian-American Enterprise Fund. The RAEF was established in 1994 by the US Congress and was capitalised by a $56 million grant from the United States Agency for International Development. RAEF is a private US corporation whose mission is to promote free enterprise and entrepreneurship in Romania through investments in and loans to small Venture Capital
and medium-sized enterprises. At present, the Fund has a Small Business Investment Fund, a Small and Medium Loan Program and a Micro Loan Program, besides the Major Transaction Program (which is aimed more towards bigger companies). RAEF has also transferred some of its know- how to the Romanian banks it works with in its loan programs.
The Direct Investment Facility Program was launched by EBRD as is addressed to SMEs from Romania, the Balkans and the Black Sea area. A consortium of firms lead by Euroconsultants of Greece administers the program. The investments can vary between USD 500,000 to USD 2.5 million over a period ranging from 3 to 5 years. EBRD participates directly in the social capital of the investing company.
Despite that a law on venture capital exists for some years now, no Romanian venture capital fund was set up, the existing ones being all foreign and set up with governmental or international institutions support. Some of the reasons are not so much lack of funds, as lack of expertise and managerial skills in setting up and running such a fund. The state should encourage the setting up of such funds, through seed money and management skills.
This is a financing modality through which the owner of an asset (lessor) grants another party (lessee) the exclusive right of use on that asset, usually over a determined period of time, in exchange for the payment of a fee.
Leasing can be either functional leasing or financial leasing. Leasing companies were regulated through Law 90/1998 to enact GO 51/1997 on leasing operations and leasing companies and Title II of Law 99/1999.
There are already several leasing companies in Romania, the most important assets being leased being cars, computers, industrial equipment, buildings etc. This instrument should be strengthened, as it is a very good answer to the shortage of collaterals and the need of financing of SMEs.
There are four banks in Romania that carry out factoring activities: Banca Comerciala Romana (BCR), Demirbank, Banca Romana de Dezvoltare Groupe Societe Generale and Volksbank. While BCR and Demirbank carry out factoring both for exports and the domestic transactions, BRD carries out factoring only for exports, while Volksbank - only for the domestic market.
For example, BCR aims its factoring activity at SMEs. Activity started in 1998 and doubled, even tripled each year, with most of their clients being SMEs. Factoring is also a protection method that offers certainty of receiving payment as liabilities are sold to the bank.
Romanian legislation is nearly inexistent in this field, with problems appearing at repatriation of hard currencies that remain in the task of the economic operators although they are no longer responsible with this.
For a better use of this financial instrument we propose that it should be better publicised, increasing the awareness of SMEs as to its usefulness.
Also there should be an improved collaboration with partner countries, with their adhesion to international factoring organisations like Factors Chain International in order for the banks to carry out the transactions in a regulated framework. For example, the BCRs factoring director complained that in Leasing
Factoring
Bulgaria they had no correspondent, which impedes their activity in that relation.
The Bucharest Stock Exchange (BVB) could be an important financing source for medium-sized firms that are ready to go public. However, it is undercapitalised and with a very low activity. The local culture is also such that it is not seen as a viable instrument for attracting funds.
There are also some grant schemes, of which we can mention the Economic and Social Cohesion PHARE 2000 Program that is a joint EU-Romania program with a total budget of EURO 113 million, of which EU grants EURO 88 million. The program will be carried out through the Ministry of Development and Forecasting and the 8 Regional Development Agencies and will be aimed at supporting SME investments for the introduction of modern technologies, support for start-ups and SME development, and supporting SME access to unused assets resulted from the restructuring of state-owned enterprises. The financing per project will be between EURO 10,000 to 50,000 for a maximum of 18 months. The grant cannot exceed 60% of the projects total cost.
The PHARE 2001 Program is still being designed and will probably offer grants for start-ups and for SME cooperation projects, in total amount of EURO 132 million.
2.2. GENERAL ACCESS TO FINANCING
Small and medium-sized enterprises operate in a highly deteriorated environment in which barriers to their establishment and growth are very evident. Economic indicators show a macroeconomic environment characterised by continuous inflation, constant devaluation of the local currency against hard currency, reduced public and private investment, and decline in the GDP with an associated fall in the internal demand.
State monopolies and/or state dominance in many industrial sectors, mostly loss-making, prevents co-operation between small enterprises and large ones. A common feature is that large enterprises, particularly those in state ownership, tend not to respect their payment obligations and to pay slowly and late.
As a consequence of the eroded credibility, which makes it difficult for the country to borrow from the international financial market, the state is increasingly forced to borrow in the domestic market, with a crowding-out effect on the banking sector. This in turn has an impact on the amount of credit available for enterprise investment.
In the recent past, several surveys have investigated the difficulties that SMEs face in Romania.
Access to market
After the collapse of the previous internal market of the command economies, Romania has been forced to look for new markets. Currently, most import Stock exchange
Grants
and export is with EU member states. Access to both the domestic and the foreign markets, however, remains limited for a number of reasons: low quality of production, high cost and consequently non-competitive price, poor marketing including unattractive packaging, poor technical assistance etc.
In particular, however, Romanian companies are frustrated by the awareness that their products are not internationally competitive. They believe this to be caused by lack of modern equipment and reduced access to technology.
This, in turn, is in part due to difficult access to investment finance.
Access to finance
Very often it is affirmed that access to finance is more important than the cost of that finance. Romanian companies do not seem to share this statement, as the cost of finance in Romania is prohibitive, with a considerable impact on the profit and loss account and thence the balance sheets. Projects would need to show a very high rate of return in order to cover an interest rate on loan that is, at present, around 15% annually on hard currency loans and 65% on local currency loans.
Leasing is not a widespread practice to access equipment, as it is in Western countries. Venture capital is a very selective finance instrument, which could not eventually have a massive impact on the SME sector. The available instruments, therefore, such as suppliers credit, bank loans and enterprise trade credit, still represents the bulk of SME finance. Romania is still a case of a cash economy. Most payments are on sight due to lack of trust and the material inability of suppliers to finance their clients. Bank loans are difficult to access in the first instance because of their high cost. Secondly, the specific situation of the banking system, which until the recent past had exceptionally high rates of default, imposes a tight financial prudence. The National Bank of Romania requires banks to cover loans with adequate collateral amounting up to the loan amount plus the amount of the first year interest rates, for example for a loan of ROL 100 the value of collateral should be at least ROL 160.
Given the long procedures for registering collateral, problems associated with collateralisation add to the cost issue.
Access to modern technology and quality supplies
Romanian enterprises have sufficient information on modern technology in the respective sector of activity. What is still underestimated is perhaps the importance of the know-how associated with each technology, e.g. the optimal layout of the working place where the machine is to be located, the maintenance schedule and practice of the purchased equipment, the quality of raw materials to use with a certain technology and how to do things right at the first attempt. Organisational issues in production and services are not dealt with effectively. A very low proportion of industrial assets are insured.
Quality is still a critical issue both in services and manufacturing.
Access to public procurement
SMEs are under-represented as contractors in public procurement works and services, with the exception of the construction service. In other sectors, large state-owned enterprises or foreign enterprises have better chances