Romanian export analysis fooled by impact of higher VAT in 2010

I do not find it very interesting to talk about data releases. But sometimes a title in a newspaper that claims something that seems preposterous raises my interest to investigate further.

It happened yesterday with the trade data for Romania. Before I saw the press release from the National Institute of Statistics, all I could hear was: fear of falling exports obliterated, pessimists proven wrong, exports grow by 24% relative to the same month last year. Immediately “independent” analysts gave their opinion praising the export sector and the Romanian economy as a whole.  As I live on planet earth and I see what the world is going through I immediately picked up the press release from the INS.

What do you know? Right there in black and white I was staring at the amazing performance of the mighty Romanian goods. How could this be? How can I miss this? How is it that we do not feel this outstanding performance in our lives?

As always the devil is in the details. I am attaching the monthly exports/imports since January 2010 in both Millions of RON and EUR.  You see something that catches your eye?

1)  While both exports and imports have increased since January 2010 it seems to me that throughout 2011 exports have remain flat on average. Moreover, August relative to July 2011 we see a drop in both EUR and RON.

2) The same goes for the trade deficit which does not show either deterioration or improvement during 2011.

3) The performance of 24% in August 2011 versus August 2010 should be obvious now. August 2010 shows a big drop in both exports and import due to new VAT level.

 

I am sorry to spoil the party but the good export numbers expressed as rate of growth are just due to what statisticians call: base effect. The lower level of exports in August 2010 due to higher VAT has allowed for normal performance to look outstanding in relative terms. In fact if we take the actual value for both EUR and RON, current level of exports is exactly the same as at the end of September 2010. Nothing outstanding about that.

 

 

 

 

 

 

 

 

 

 

14 thoughts on “Romanian export analysis fooled by impact of higher VAT in 2010

  1. I’m not sure it’s the VAT. Exports to EU countries (called intra-community deliveries) are VAT exempted by applying the reverse charge mechanism (the Romanian supplier issues an invoice without VAT). Exports to non-EU member states are also exempted, given certain conditions. The base effect should therefore be visible to Romanian consumers or Romanian companies, and not to exports since no VAT is charged. Maybe we should account that other categories (mainly agricultural), or more competitive goods are now available for export.

    1. I think VAT worked through higher production costs. The drop in both imports and exports shows to me that consumption and production domestically came at a halt in the month following the VAT increase. But I understand your point and maybe someone will do the analysis further. To me the story is already told by the September 2010 versus August 2011 evolution. There is a good probability that next month we will see a negative growth in exports.

  2. VAT is a neutral tax for companies. This means that if a company buys raw material for 100 dollars in june 2010 it has to pay 100 + 19% input VAT in Romania, a total of 119 USD. The 19 USD are deductible. Let’s assume that it has 50 USD in labour costs and ads a 10 USD profit margin. The total costs will be 100+50+10=160 USD. If it will sell the goods to a Romanian consumer/company it will invoice 160+19% = 190.4 USD. In this case the company will cash in 190.4 USD and has the obligation to pay to the state 30.4 USD as VAT. But the company also has the right to deduct input VAT, so it will only pay 30.4 – 19= 11.4 USD. If it were to sell the goods to a foreign company, it would invoice 160 USD and the state should reimburse the company the 19 USD representing input VAT paid for the raw material.

    This means that VAT will not influence the production cost.

    If the company bought raw material in June 2010 but sold the finished goods in August 2010 to a Romanian company, then the company would have to invoice 160 + 24% = 198.4 USD. The company is entitled to 160 USD, while 38.4 USD are to be paid to the state. The company has the right do deduct 19 USd so it will finally pay to the state 19.4 USD. If it were to sell the goods to a foreign company it would invoice 160 USD and wait for the state to pay the 19 USD representing input VAT.

    In this second case, VAT will generate a one-off cost to the company if the finished goods were to be sold to Romanian consumers/companies. This cost would amount to 19.4 (amount paid in august) – 11.4 (how much would have been paid if the VAT rate would have been the same) = 8 USD.
    If the company were to sell the finished goods to a foreign company, then no additional cost would be incurred.

    So companies with large inventories would have found themselvs in a better position if they were to export goods rather then sell them on the Romanian market.
    This is why I believe that exports have nothing to do with VAT.

    P.S: Sorry about the long post, but I had to explaind these things.

    1. I see. If what you are saying is true than VAT should not be showing up in inflation. Or better yet is should not show up in industrial prices. Something does not make sense. VAT is a cost to the economy affecting domestic aggregate demand. If the effect is neutral for companies than I do not see any reason for not making VAT 100%.

      To me the coincidence is too big and for now the only explanation for the big drop in trade. If you look at data for EU you will see that there was no shock to aggregate demand at that time. Also, remember that above 70% of our imports are used as intermediaries for the export sector.

      BTW thank you for the comment and the accounting lesson.

      1. VAT affects agregate demand because the final consumer will pay the price+vat, so if the VAT rate goes up, so will the prices for those who are unable to deduct it. And since Romania has few competitive markets, the increase will most likely be passed on to the consumer, without companies having to negatively adjust they’re profit margins (resulting in a increase in industrial prices).

        Now take in to account the fact that a large part of the population spends its income on goods with an inelastic demand (basic products: food, clothes, tobacco). Increasing the price will not determine people to stop buying these goods but will reduce the purchasing power. The companies which will be troubled by an increase in VAT are those who operate in the higher -added value sectors, for which demand will drop sharply. So you will have both inflation and a sharp drop of the AD.

        On the other hand, if 70% of our imports are, as you say, intermediaries for the export sector and the exports do not generate high yields, then there could have been a negative cash flow impact on those respective companies. I am not sure however if the impact is high enough to generate a strong reduction in export. There is also another thing, if the company has to operate on a competitive export market, it would find it difficult to pass on this cost to its consumers.
        It is not clear however how many companies have been in this position.

      1. My work day seems to be suprinsingly idle so I had the time to look a bit at the paper. It has some interesting assertions. I do not think VAT itself can directly impede export or import. However if the legal VAT procedures are not clear or reimbursement takes (as in Romania) several month, then it can hinder commerce. And the thing is the bigger the government sector (G as %GDP), the more inneficient it becomes (there are exceptions of course).

      2. I am glad you chose to read my stuff instead of surfing the web or mess to your pals. very good comments. Maybe we need to model trade and identify the VAT shock. Could be a nice research paper.

  3. I looked over the statistics of the last 6 years and it seems that every year in August is a significant drop in exports relative to previous months. I think that companies reduce their activity in August due to an increase in the number of employees who go on vacation.
    Month Exports Imports Deficit
    Jul-06 2,212.2 3,445.4 -1,233.2
    Aug-06 2,001.4 3,346.5 -1,345.1
    Sep-06 2,199.6 3,380.6 -1,181.0

    Jul-07 2,656.3 4,459.0 -1,802.7
    Aug-07 2,252.7 4,070.7 -1,818.0
    Sep-07 2,500.5 4,219.1 -1,718.6

    Jul-08 3,251.6 5,330.5 -2,078.9
    Aug-08 2,657.1 4,506.2 -1,849.1
    Sep-08 2,961.5 5,395.2 -2,433.7

    Jul-09 2,801.2 3,359.1 -557.9
    Aug-09 2,207.8 2,951.6 -743.8
    Sep-09 2,604.2 3,771.2 -1,167.0

    Jul-10 3,389.2 4,048.9 -659.7
    Aug-10 2,783.7 3,413.6 -629.9
    Sep-10 3,519.2 4,352.5 -833.3

    Jul-11 3,779.5 4,415.9 -636.4
    Aug-11 3,460.3 4,311.3 -851.0

    (Numbers are millions EUR)

  4. Numbers were not displayed well. I hope this will show better:
    Month Exports Imports Deficit
    Jul-06 2,212.2 3,445.4 -1,233.2
    Aug-06 2,001.4 3,346.5 -1,345.1
    Sep-06 2,199.6 3,380.6 -1,181.0

    Jul-07 2,656.3 4,459.0 -1,802.7
    Aug-07 2,252.7 4,070.7 -1,818.0
    Sep-07 2,500.5 4,219.1 -1,718.6

    Jul-08 3,251.6 5,330.5 -2,078.9
    Aug-08 2,657.1 4,506.2 -1,849.1
    Sep-08 2,961.5 5,395.2 -2,433.7

    Jul-09 2,801.2 3,359.1 -557.9
    Aug-09 2,207.8 2,951.6 -743.8
    Sep-09 2,604.2 3,771.2 -1,167.0

    Jul-10 3,389.2 4,048.9 -659.7
    Aug-10 2,783.7 3,413.6 -629.9
    Sep-10 3,519.2 4,352.5 -833.3

    Jul-11 3,779.5 4,415.9 -636.4
    Aug-11 3,460.3 4,311.3 -851.0

    1. I think there is some truth to this. Still, the drop in August 2010 relative to July 2010 and then the pick up in September 2010 looks odd. Either more people took holidays in August 2010 than in 2011 or companies hired more people just for August 2011. Let’s see the dynamic next month and will return to the issue.

  5. @DDR

    You are right in respect to the accounting, except I can’t agree with “a company is neutral to VAT, it only affects the demand”. This is not actually true, not even in accounting🙂.

    But a VAT increase could have an impact, although may be not huge, on exports also, doesn’t matter the accounting. In the final consumption, overall, just around 2% of the VAT were included in the final price. Which means that it is possible at the production level that some companies increased more or less their price, taking the vat into account, and an exporter may have changed suppliers, or may have renegotiated, or something alike, as a response to changing in the business environment. In the business world things are not like mathematics. As a producer you’re not necessary ready to buy copper at 5% plus to the price, because of the VAT increase. May be another company is willing to sell it at only 3% increase in price🙂.

    I’m not saying that Florin is right regarding the VAT and the exports, or that you are wrong. I’m saying that your mathematics is perfect, but business is not mathematics, we shouldn’t see it like this. The producers could have experienced a changing of suppliers, or contracts, or something, which may have created a little decrease in their activity.

    1. I started the blog to structure my thoughts a little bit better and to not loose touch with the day to day economic reality. I chose English for two reasons:
      1) International investors need an independent voice about Romanian economics
      2) I cover also international subjects and if I say something stupid there is a better chance I get corrected. This is true, by the way, for subjects about Romania also.

      However, I am in talks with a local news agency to provide couple of articles a week in Romanian. Let’s see if it will work out.

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