European Union, eastern enlargement, capital market, Romanian economy

George Ionescu

English

Research Papers in Economics

 
25 
THE ENLARGEMENT OF EUROPEAN UNION AND THE 
ROMANIAN CAPITAL MARKET 
 
George Ionescu
∗ 
 
I. Introduction 
 
At this relatively early stage in the development of financial markets in the accession 
countries, it seems more appropriate to refer to the financial sector rather than the capital 
market, since the latter is not yet very well developed. It is the same problem with the 
Bucharest Stock Exchange, re-openend after 50 years of socialism, which is totally 
engaged on fulfilling its mission to serve as an efficient, fair rule-based market which 
should be attractive and match European standards. 
The functional culmination of European Economic and Monetary Union (EMU) 
came on 1 January 2002, when euro banknotes and coins entered circulation. Now all that 
remains is the geographical completion of the Monetary Union. The process of 
enlargement is the most decisive step towards finalizing this as a whole, not forgetting 
those countries that are already members of the European Union but are outside the euro 
area.  
Enlargement will benefit all the sides involved. Economic integration is not a zero-
sum game in which for there to be winners, there have to be losers. As economic theory 
has shown, surpluses can be generated from economic and financial exchange. 
Consumers, savers, business people, workers, investors, each and every economic agent 
can benefit from the accession process. The European Union itself, its institutions and its 
currency, will emerge stronger as a result of welcoming new Member States, as long as 
the integration process is handled well and is completed successfully.  
It should be made clear from the outset that EU enlargement is a political process. 
Indeed, it is such a large undertaking that I think it is difficult to grasp its full impact. We 
lack the necessary time perspective in the same way that we still lack the historical 
distance needed to understand the full implications of having more than 300 million 
people using the euro for their accounts and payments. 
 
II. The key areas of monetary and financial integration 
 
In the process of EU monetary and financial integration, there are three key areas: 
legal/institutional, logistical/technical and economic. Considering the together fist two 
key areas of financial integration, there can be no enlargement of the European Union or 
the Economic and Monetary Union without the prior legal and institutional convergence 
that allows the accession countries to adopt the Community acquis and without an 
appropriate technical supporting system. It is important that the acquis must be applied in 
the financial sector in general, and to central banking activities in particular, in order to 
ensure a solid legal context. For its part, the Eurosystem has focused on: the financial 
                                                           
∗ George Ionescu is Associate Professor of Financial Markets and Investments and Portfolio 
Risk Management at the Romanian American University in Bucharest.  
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legislation of the accession countries (especially with regard to the free movement of 
capital and payments); regulation of the financial markets with regard to the provision of 
banking, securities and investment services; rules governing eligible assets; and 
legislation paving the way for an internal financial services market.  
At the economic level we can identify four main action areas: the accomplishment of 
the convergence criteria; exchange rate policy; the instruments and processes of monetary 
policy; and statistics. Most of these aspects provide the basis for understanding the 
functioning of capital markets in the accession countries and its interplay with the euro-
area capital markets.  
The most important economic aspect with regard to acceding Romania’s membership 
of Monetary Union is the accomplishment of the nominal "Maastricht" convergence 
criteria. As was the case for the 25 current members, this is the economic key to the door. 
It is important to understand that the accomplishment of the convergence criteria by the 
acceding countries must be sustainable, as was set out clearly in Article 109J(1) of the 
Treaty of Maastricht and in Article 1 of Protocol no.6.  
 
III. The impact EU integration for Romanian financial sector 
 
For a better understanding of the impact of EU integration for Romanian financial 
sector, we have to look at what happened with the ten new joined EU states. At the time 
of their accession, in May 2004, there was a great diversity between the accession 
countries, talking about the economic situation also extends to their exchange rate 
strategies. Between them, the ten states had a wide variety of exchange rate regimes, 
ranging from independent floating (Poland and the Czech Republic), to currency boards 
(Estonia and Lithuania), managed floating, informally using the euro as the reference 
currency (Slovakia and Slovenia), pegging to a basket of currencies with a greater (Malta) 
or lesser (Latvia) weighting for the euro and, finally, pegging to the euro within 
fluctuation bands of ± 15% (Cyprus and Hungary), a practice reminiscent of that used by 
the Exchange Rate Mechanism II (ERM II).  
Over the last decade, these countries have experienced remarkable transformations in 
their financial sectors. This was primarily driven by the transition process in Central and 
Eastern Europe and by the prospect of EU membership. In particular, considerable 
progress has been made in restructuring and consolidating the banking sector, thanks to 
the large-scale privatization of state-owned banks, the liberalization of markets and the 
extensive opening-up of the banking sector to foreign ownership.  
In parallel, the accession countries' economies have been fundamentally transformed 
by the establishment of macroeconomic stability and the privatization of assets. 
Moreover, structural reforms have been made in many areas, and public institutions have 
been reformed and improved.  
This restructuring process in both the financial sector and the real economy is well 
advanced and a new phase of financial and economic development is now under way in 
all the accession countries. EU enlargement and the prospect of the eventual adoption of 
the euro implies the need for the countries concerned to consolidate economic practices 
and enforce financial regulations and operational procedures in the euro area. This calls 
for the further refinement of the concept of a "functioning market economy and the ability 
to cope with competitive pressures", one of the so-called Copenhagen economic criterion  
27 
for EU accession. Actual compliance with this criterion requires the accession countries 
to further strengthen their financial sectors as the linchpin for balanced and sustainable 
economic growth.  
The traditional role of the financial sector in underpinning investment and realizing 
growth potential through its intermediation and governance functions is still very limited 
in most accession countries. For example, with the exception of Cyprus and Malta, which 
display a ratio comparable with that of the euro area, the level of financial intermediation 
in central and eastern European countries is relatively low and the provision of bank 
financing represents a much smaller share of GDP than in the euro area. To give you 
some figures, bank assets in the euro area amount to about 265% of GDP, whereas the 
bulk of accession countries' banking systems have asset volumes amounting to between 
30% and 100% of GDP. At the mid-year 2004, the level of financial intermediation in 
Romania was approximately 50%, compared with the 75% in central European countries 
in the same period. The forecast for the next three years is that financial intermediation 
will reach 100% of GDP. 
Due to the relatively prominent role of the banking industry in accession countries' 
financial sectors – or the correspondingly limited development of capital markets – the 
low level of financial intermediation has become an obstacle for credit institutions to 
channel financial savings into investment.  
In some countries, specific features of the corporate sector alleviate this constraint 
through extensive recourse to the international financing provided by multinationals. By 
contrast, the role of capital markets as a source of financing is not sufficient to offset the 
activity of the banking sector. As regards stock markets, the total market capitalization of 
acceding countries combined stood at around 52% of GDP in the euro area. Turning to 
bond markets, unlike in the EU, their role has traditionally been limited in terms of 
accession country financing, mainly as a result of low levels of outstanding government 
securities. Even though the levels of fiscal deficit have been high in some countries, the 
average general government debt outstanding at end-2002 amounted to only around 40% 
of GDP, compared with an average of 70% of GDP in the euro area.  
Although the banking industry in accession countries is widely considered as stable 
and sound, it has its structural weaknesses and inefficiencies – for example, those 
reflected in the continued high spreads between lending and deposit rates or the relatively 
large proportion of bad loans in some countries. These weaknesses require that an extra 
effort be made to consolidate the financial sector and to avoid adverse future 
implications.  
 
IV. Romanian capital market and European Union membership 
 
Overall, enhancing the efficiency of the financial sector in accession countries is 
relevant in order to achieve full integration in the euro area's financial sector. Important 
steps towards this integration have already been taken and are clearly visible. In the 
banking sector, for example, the strong presence of foreign banks has already had 
significant implications, accelerating concentration, increasing competition and 
enhancing efficiency.  
However, the adjustments still to be made in order for the financial sector in 
accession countries to reach euro area standards remain significant. In this context, the  
28 
changes occurring in the euro area's financial sectors imply that the accession countries 
have a moving target to catch up with. Some euro area indicators, such as degrees of 
efficiency in financial intermediation, are relevant for the accession countries' financial 
development, while other elements are not necessarily meaningful benchmarks because 
the euro area is highly heterogeneous and its financial markets are still subject to 
profound changes.  
This means that further integration with the euro area – which will be mainly market-
driven – will also need to be supported by considerable action on the part of the 
authorities. The adoption of the EU's legal framework, a greater integration of the 
financial infrastructure with that of the euro area and strong cross-border collaboration 
between supervisors are the main elements of this process.  
For example, in the specific case of covered bond legislation, this entered into force 
in a number of accession countries some years ago, for instance in the Czech Republic 
(1995), Slovakia (1996), Hungary (1997), Poland and Latvia (both in 1998), Romania 
(1999) and Bulgaria (2000).  
However, the development of this particular segment of the capital market is still at 
an early stage, reflecting the above discussion on the dominance of the financial system 
by the banking sector. To illustrate this in figures, at the end of 2002, the outstanding 
amount of euro-denominated covered bonds was EUR 1,497 billion – around 20% of the 
total amount of the euro bond market. This compares with roughly EUR 3 billion in 
accession countries. Moreover, this relatively low volume is concentrated in only two 
countries, Hungary and the Czech Republic. However, although these differences are 
significant, they should not be overstressed. In fact, in the rest of Europe, the German 
covered bond market is by far the dominant one, since it accounts for 73% of the total 
euro-denominated covered bond. In the light of the substantial differences remaining in 
the structure of the national European financial systems, we should not prematurely judge 
the current status of convergence of capital markets in accession countries, particularly at 
this early stage.  
In Romania, the positive performance of the real economy also entailed favorable 
changes in the financial sectors, the capital market included, which did not go unnoticed 
by investors, the outcome being a more intense trading in the last few years. There was a 
combination of factors that exerted a favorable impact on the capital market, such as 
sustained GDP growth, declining inflation, the appreciation of the national currency and 
the fall in banking interest rates. It is important to mention the end of the demutualization 
process of Bucharest Stock Exchange (BSE), with financials intermediaries becoming 
shareholders of the commercial company Bucharest Stock Exchange SA. 
The demutualization of BSE, the merger with the RASDAQ electronic exchange and 
with the Sibiu Financial Monetary and Commodities Exchange, opens the possibility of 
creating a powerful exchange in this region, These mergers were planned with a view to 
creating, which in 2007 to be able to cope with international competition. This 
development strategy means that BSE has to reposition itself regionally and look equally 
attractive to Romanian and European investors.  
The indices of the Bucharest Stock Exchange posted remarkable growth rates in 
2004, this placing the BSE in the category of European stock markets that offered 
investors the highest returns on their financial placements. In 2004 the BET-C composite 
index grew by 114.13%. The CESI index of the Central European stock exchanges grew  
29 
by 65.40% in 2004, while EUROSTOXX50 grew by 5.49%. Such rises in stock exchange 
indices occurred against the background of intensified trading, the total value (shares and 
bonds) traded in 2004 on the Bucharest Stock Exchange standing at EUR 667.81 million. 
The favorable market tendencies also showed in the greater market capitalization by over 
194.84% as expressed in EUR which by end 2004 stood at EUR 8.82 billion. 
The same positive evolution of BSE was observed in 2005. The composite index of 
BSE (BET-C) grew by 46.16%, compared with EUROSTOXX50 which grew only by 
20.50%. Total value (shares and bonds) traded on the BSE standing at EUR 2.15 billion, a 
remarkable 360% growth from the total value traded in 2004, sustained by a market 
capitalization of EUR 15.3 billion. 
 
V. Conclusions 
 
Looking back to the early years of the BSE, the progress is obvious and substantial. 
In the context of a comparison to neighboring countries, we will realize that while in 
2002 BSE ranked sixth, with a market capitalization of EUR 2.6 billion, in 2004 it ranked 
fourth with EUR 8.8 billion. At the end of 2005 the market capitalization was over EUR 
15 billion, approximately 20% of GDP. 
In transition economies, stock market evolution gives very clear signals determining the 
way investors perceive the economic environment of a country, and also as major signals for 
economic policymakers. Thus, a stock exchange that holds a good regional position can serve 
the country’s image, especially in view of the European Union membership looming ahead. It 
is very important for BSE to participate, and become the promoter of a regional virtual market 
which to serve the important Romanian listed companies as the necessary channel to regional 
capital in flows without losing the domestic one.  
It is essential that Romania create a modern financial market infrastructure. 
Preparatory work in this field is subject to very long lead times and, therefore, needs to be 
implemented years before the adoption of the euro. Moreover, the target of this 
preparatory work is a moving one, and it may be moving faster than other targets. Certain 
components of the euro area financial infrastructure may need to be dynamically adapted 
before Romania can be integrated into the euro area.  
In any case, development of the financial systems in Romania needs to be consistent 
with economic convergence. In this respect we can mention the case of fixed-rate bond 
markets: without convergence of inflation towards euro-area levels, it will be difficult, if 
at all possible, to promote the bond market. This also applies to the covered bond market 
in particular. The relevance of such development is based on the fact that the financial 
sector plays a key role in strengthening and broadening economic growth, as well as 
fostering stability. In order to promote financial development, without compromising 
hard-won financial stability, it seems crucial at this stage to complete a number of 
structural reforms. Moreover, a fully integrated capital market in Europe, including the 
accession countries, may be considered an aim in itself and an ultimate hard test for a 
truly successful enlargement.  
In conclusion, although a new era of financial development in Romania is now in full 
swing, the challenges ahead are still considerable. Despite the remarkable progress made 
in recent years and the ongoing adjustment to euro area standards, the Romanian financial 
sectors need to undertake further significant changes in the future.  

The Enlargement of European Union and the Romanian Capital Market

http://www.rebe.rau.ro/RePEc/rau/journl/SP06/REBE-SP06-A3.pdf

The Enlargement of European Union and the Romanian Capital Market

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