Romania’s Government on December 21 passed an emergency ordinance with major impact on the energy and telecom companies, banks, the pension system and the public budget. The ordinance includes a so-called “greed tax” on bank assets and turnover taxes for the energy and telecom sectors.

The Economic and Social Committee that brings together investors’ associations, trade unions and civil society representatives, issued a negative, yet consultative review after the investors’ associations and other stakeholders invited the executive to more consultations before a final decision.

The document was not published in the Official Gazette yet (as of December 27) and some of its provisions were changed compared to the initial draft posted online for public consultations just days before the Government meeting, but the most important ones were presented by finance minister Eugen Teodorovici and former finance minister Darius Valcov, now an economic advisor to PM Viorica Dancila and the main economic strategist of the ruling party PSD, in a one-hour press conference after the Government meeting on December 21. In principle, the provisions included in the ordinance can still be revised when passed by the Parliament, but it comes into force and starts producing effects once published in the Official Gazette -- most likely before January 1, while the debate in the Parliament will take place next year.

Notably, the phrasing in the initial draft was unclear in some respects and the government officials clarified only part of the issues in their press conference. Some important ones, such as the calculation of the tax on the banks’ assets and the minimum mandatory capitalization of the pension funds managers are still to be clarified.

Sundry collection of provisions aimed at social justice

The most visible feature of the ordinance is the multitude of different targets, all of them justified by the need of pursuing in a direct way the social justice, rather than building a regulatory framework aimed at optimum allocation of resources (with social protection as an intervention declared as such).

The Government will finance local infrastructure and social projects by arbitrary decision of the National Prognosis and Strategy Commission (CNSP) at preferential 1% interest rate up to a limit of EUR 10 billion; will finance sports kindergartens and thermal spa resorts, to be developed by private entities; will levy supplementary tax on financial assets (mostly relevant for banks); will cut the fees charged by the mandatory pension funds’ managers and will set minimum required capitalization for them; will cap the local natural gas price for residential and industrial consumers and tighter regulate the electricity price for residential users (by a subsequent order of the energy market regulator ANRE); will cut the social contributions paid by employees in construction.

Most of the moves are not aimed at bringing supplementary money to the budget (on the contrary, in some cases), but improve the standard of living and help locally-owned companies, Government officials argued. The revenues from the tax on revenues of the energy companies (thermal producers excluded), for instance, will be used to provide subsidies to vulnerable consumers under a mechanism to be further elaborated. The tax on financial assets is aimed at bringing down the interest rates on the money market (used as an index for the calculation of the taxes), they explained.

On the other hands, Government officials and the ruling coalition’s leader Liviu Dragnea made clear that one of their final goals is make the companies (particularly foreign ones, although the results are debatable in this regard) make less profit to the benefit of end-users / population.

The order addresses real problems, the wrong way

The order addresses real and urgent problems, finance minister Eugen Teodorovici argued: the abnormally low profits reported (hence profit taxes paid) by multinational companies in energy and telecom, the equally abnormal, high profits in the banking sector and the high energy prices paid by both residential and industrial users.

The central bank’s latest Financial Stability Report spots market failure problems, Teodorovici said.

“Banking sector profitability is well above the EU average[…] Low financial intermediation is associated with a wide spread between lending and deposit rates, for households in particular.[…] Banks’ business model continues to focus on retail lending, given the more favorable track record of risk-adjusted returns”, the report reads.

The banks and energy suppliers colluded and set high prices (interest rates) and the transfer pricing is extensively used with the outcome of dismal profit taxes collected to the budget, Teodorovici implied. The return on equity posted by banks in Romania is triple the EU average, he pointed. This is confirmed by European Bank Association for January-June this year (21.2% versus 7.2%), but only for the three largest local banks -- while the overall market average ROE is only 15.7% (16.7% for January-September) according to central bank data.

The second pillar of the pension system was another key point of the ordinance. The EUR 100 million collected by the seven private fund management firms with 22 employees each are too much, while the capitalization of the asset management firm is too low. There are sectors that need no interventions, like the automotive production, Teodorovici added.

There is an oligopoly situation in the natural gas market, Teodorovici also argued explaining that the European Union’s regulation allows for interventions with a duration of up to three years in this regard. The local producers lack export capacity and the offshore gas will not start flowing before the end of the three-year price setting dictated by the Government.

The problems outlined are real and worth at least serious debates. More than that, they are only part of the multitude of causes that contributed to the general government budget revenues of under 30% of GDP (compared to 40% typical value in EU states). Out of the 10pps differential, only VAT evasion accounts for 4pp. At a 40% of GDP level of budget revenues, the wage hikes in the public sector would have not posed any problem and large public infrastructure projects could be financed. But the steps proposed by the Government are risky and the long-term benefits questionable.

Instead of addressing the market failures in the sense of improving the institutional and regulatory architecture, it relies on more regulated prices, fees and centralized allocation of funds. The final purpose is low energy prices, affordable mortgage loans and thriving investments in utilities, education and healthcare.

Banks have to pay tax on financial assets

The banks will pay a tax on their financial assets when the average interbank offer rate - ROBOR for the maturities of three and six months exceeds the 2% benchmark. For the average ROBOR between 2% and 2.5%, the tax will be calculated as 0.1% of the financial assets with the tax rate rising proportionally with the average ROBOR rate (0.2% for 2.5%-3% average ROBOR, etc.). As per the provisions in the preliminary draft, the tax is payable on a quarterly basis with no annualisation (that would mean dividing by four the tax as calculated by levying the tax rate on the volume of assets at the end of the quarter). However, banks argue annualisation would make more sense in the context of the other taxes paid. A final clarification from authorities is needed. In any case, the tax on financial assets is deductible for the profit tax purposes.

To put in perspective the magnitude of the tax on financial assets, the banking system reported return on assets (ROA) of 1.76% (annualised) in January-September 2018, after 1.3% in 2017, 1.1% in 2016 and 1.2% in 2015. If calculated under the most favorable formula (annualised), the tax on financial assets would account for a part of the banks’ profits not threatening, though, their viability. It is unclear, however, whether the current profitability rates are sustainable on medium term since they reflect to some extent the non-performing loan cycle. Possibly, the Government considers ad-hoc measures for extraordinary situations but wants to have the situation under control. If the tax is calculated under the least favorable formula, it will cost a significant part of banks’ profits putting at risk the smaller banks that can’t boast high profitability rates -- which would accelerate the consolidation in the sector.

Pension funds managers see their business at risk

The seven pension funds managers with 22 employees on average collected EUR 100 million in fees during 2018, finance minister Teodorovici stated. Concluding that this is too much, the Government cut the fees as follows: only 1% of the contributions that enter the funds each month (from 2.5% currently), and out of this 0.5pp will go to the fund managers and the rest of 0.5pp to the public pension managers (first pillar). The 2.5% fee was aimed at being charged only over the first five years of life, with the fund management companies supposed to have gained capitalization during this period, Government officials explained. The 0.6% annual fee charged on the stock of assets managed (0.05% per month) will be changed into progressive fee of 0.02% to 0.07% per month depending on the yield generated by the fund managed. The 0.07% fee will be charged by those managers achieving real yields of more than 4%. As of September 2018, the average yield calculated for the past 24 months was 3.8%, versus average consumer price inflation of 2.5%. The real yield (1.3%) under this metric is at the lowest level since the end of 2012. At this level, the fee charged would be 0.04% per month, versus 0.05% currently. But the 24-month average real yield hit values as high as 7%-8% since the end of 2012 and even higher during 2010. For putting this into perspective, the market regulator cut the regulated rate of profitability for the electricity distribution firms to 5.7% as of January 2019 from 7.7% currently. The Chinese investors negotiating for the development of the nuclear reactors at Cernavoda reportedly ask for 11% internal rate of return for their capital.

As a final note on the fees, the draft order does not specify methodologies for comparing the yield and the inflation rate. In practice, the monthly yields can vary substantially from one month to another. The scale of real yields suggests annual yields, but also 12-month annual yields would be an option (to avoid volatility).

The tougher requirement regards the capitalization of the fund managers: up to 10% of the funds managed, for the large-sized funds. Notably, the smaller funds are set proportionally lower capitalization requirements (5% for EUR 100 million or less assets managed, to 10% for assets managed in excess of EUR 500 million). In principle, this comes against the trend toward consolidation. Nonetheless, the consolidation can be achieved at a higher level (parent group) and such a trend can’t be ignored. One issue not yet addressed regards the situation when no fund manager is willing to remain in the market. Possibly, the assets will be transferred to the first pillar.

As explained by minister Teodorovici, the contributors to the second pillar are given the option to switch to the first pillar after five years of contribution. This means that their 25% of the gross wage will go entirely to the first pillar. The assets accumulated in the second pillar remain under private management and will be recovered at retirement. Currently, 2.75% of the gross wage is distributed to the second pillar. Under a provision circulated by government officials, the residents being employed after the order comes in force will no longer have the option of contributing to the privately-managed pension funds. But the preliminary draft (and the only one available until the final draft is published) does not specify this.

Natural gas prices will be capped, electricity price regulated

The natural gas price charged by local producers is capped at RON 68 (EUR 14.6) per MWh. For comparison, the gas is traded currently on the free market at around RON 95 (EUR 20.4) per MWh and this is the price used for the formation of the end-user price. But the price cut will be not felt proportionally by the end-users, since part of the end-user price include the transport and distribution fees, plus taxes.

Residential users will preferentially be given gas produced locally while the industry will be delivered a basket of local and imported gas. More precisely, the market regulator will calculate the price of the basket including local and imported gas for non-residential users. The provision is valid since April 1, 2019 for a period of three years.

The electricity price for residential end-users will be capped as well, but under a specific order of the market regulator ANRE, minister Teodorovici explained. The residential end-users have the option to return to their supplier of last resort, in case they opted for another supplier under the market liberalization procedures. Only the suppliers of last resort will be those observing the prices set by ANRE.

The moves come against the market liberalization. But, at least in the case of natural gas, minister Teodorovici claims it addresses a situation of oligopoly. Indeed, the European natural gas market can hardly be described as a model of free market but the three-year suspension of the free-market provisions should be notified to (and approved by) the European Commission. Admittedly, the Government plans to get the EC’s permission until the natural gas price is capped at April 1. Notably, this will happen during the Romanian presidency of the European Union. Coupled with the development in good faith of the interconnection lines (including BRUA project), the price cap might be accepted by the Commission. The main risk comes from local producers cutting their output.

On a pragmatic note, minister Teodorovici explained in the December 21 press conference that local companies will not have the option to export their natural gas within the next three years. And they need revenues, he implied, meaning that they will not decrease excessively their output.

Another key provision pertaining the energy sector regards the 2% tax on the turnover of energy companies: those operating in the natural gas and electricity markets. The companies delivering heating, or the co-generation plants, for the heating business, will not be charged this tax. This is a more direct way of extracting resources from the energy companies, compared to the dividends paid this year, minister Teodorovici implied. Furthermore, it will be done at the expense of the minority shareholders, who have collected significant dividends this year as well, besides the Government. Notably, with the capping of the natural gas and electricity prices, the profits of some of these companies will drop significantly making impossible the distribution of high dividends.

Telecoms, sanctioned for their “unfair behavior”

Another sector targeted by the ordinance is telecom, for which the Government decided to introduce a 3% turnover tax.

“For those who activate in this sector, a tax has been set that will be paid to ANCOM (the telecom sector regulator – e.n.) – of 3%. This tax comes as a result of a behavior that has been analyzed and considered unfair by Romania’s Government by those that have to pay profit tax in this sector,” said Darius Valcov in the December 21 press conference. He gave the example of market leaders Orange and Vodafone, which paid profit taxes amounting to 7.2 per-mille, respectively 9 per-mille, of their turnovers in 2017. Another operator, that Valcov avoided to nominate, paid a profit tax of RON 1.577 (EUR 339) at a turnover of RON 3.3 billion (EUR 710 million), he said.

Moreover, the Government also set the minimum prices telecom operators will have to pay for the 5G licenses that will be auctioned at the end of 2019 and for the renewal of 2G and 3G license, also to be carried out next year. Thus, the authorities aim to sell the 5G licenses for a minimum of 2% of the turnover in the electronic communications sector times the number of years for which the licenses are granted. The renewal of 2/3G licenses will cost 4% of the sector’s yearly turnover times the number of years for which the licenses are renewed.

Mobile communications operators have reacted to these taxes saying they will negatively impact their future investments, blocking the development of this important sector for Romania’s economy.

Foreign and Romanian investors warn Govt. against excessive taxation plans

Romanian companies warn supplementary taxes will surface in end-user prices

Bucharest Stock Exchange crashes after announced fiscal changes

by Iulian Ernst, Editor Romania-Insider.com; iulian@romania-insider.com

(Photo source: Shutterstock)