"Let me start by asking you a simple question: if you earn an 8% return on an investment per year is that a good investment?"
Romania’s stock exchange is on a hard sell to try and persuade more foreign investors to come and invest in its market. And it has a great pitch. This quote was the opening line from the president of the Bucharest Stock Exchange Lucian Anghel in a speech he gave to the 34th annual BACEE banking conference held in Budapest in early April.
At an average of 8%, Romanian stocks are paying some of the highest dividend yields in the world, while the market is striving to upgrade itself from frontier to emerging market status — a change that could, if it happens, see equity prices soar by 50%-200%, according to Anghel.
"The experience of other markets that have gone from frontier to emerging market status is a new pool of capital opens up and the inflow that follows can drive up prices by anywhere between 50% and 200%," Anghel says enthusiastically. "This could happen with Romania too. The transition from frontier to emerging status is a once in a lifetime opportunity."
Given the miasma that has fallen over some of the bigger markets in the region in recent years such as Turkey and Russia, the Romanian story is looking increasingly appealing. Russia had a good year in 2016, but portfolio investors feel most of the really big "catch up" growth already happened during the boom years in the noughties. What were once considered emerging markets such as Russia are starting to look increasingly mature – at least from a portfolio investor’s perspective.
Romanian stocks have yet to have the same step up to "boring" status as the country is still in the midst of its catch up phase. Economic growth has been running at over 3% pa for five years in a row and the forecast for 2018 is for yet another year of the same healthy growth. The main drivers are services, gross capital formation and consumption, says Anghel. More importantly for equity investors, the local currency has been remarkably stable, thanks to the central bank's policy of moderate interventions to maintain exchange rate stability.
"For several years now the leu has been trading at about four to five to the dollar and is very stable. That means for investors worried about currency risk it is not expansive to hedge," says Anghel. "We had the most stable currency in CEE in 2016."
Still, the country has a few challenges ahead of it. Inflation is low, too low, and is expected to turn into deflation at the end of the year, which will hurt consumer sentiment. Likewise, the country is running a large current account deficit that will need to be financed.
The evolution of the Romanian market is writ large in its market capitalisation. Between 2000 and 2008 the market cap was more or less doubling every year, rising from €450mn to a peak of €24.6bn at the end of 2007. The global financial crisis halved the market cap to €11.6bn in 2008. Since then the market has recovered all the ground lost and then some: the market cap at the end of the first quarter of this year was €34.2bn.
Going forward Anghel argues the market's value will only increase. The average dividend yield was 8% last year, although some stocks are paying much more. The government has turned to its biggest state-owned enterprises (SOEs) and to tap their cash flow is demanding up to 90% of profits be paid out as dividends. In the government’s SOE portfolio are many of the largest companies in the country, monopolists in transport, power and energy.
Another driver of local equity prices is the growing pension fund business, where assets have been growing by 20% a year and also providing demand for stocks.
There are alternatives to stocks such as the local real estate market, where prices are increasing on the back of the robust economic growth and rising income levels. But then Anghel comes back to his first question again: "Is an 8% return a good investment?"
"Romanian real estate prices have been growing strongly but the stock market is still a better investment and returning more than real estate – and it is a lot more liquid," says Anghel.