Romania's datacenter market following its recovery and resilience plan

Introduction

In May 2021, Romania submitted its recovery and resilience plan to the European Commission. The plan is structured around six pillars: the green transition, digital transformation, smart growth, social and territorial cohesion, health and resilience, and policies for the next generation. Funds will be disbursed until 2026 by the European Union, conditional on the achievement of a set of criteria and parameters set out by the European Commission. Romania's digital transformation, abundance of domestic and global internet exchange points (IXPs), low labor costs, and low corporate income tax are all strengths for developing a large datacenter market. Furthermore, a combination of cross-border terrestrial and submarine cables landing on the Black Sea coast ensures effective international data connectivity and exchange. However, Romania's economy shows some weaknesses that may prevent the country from growing its datacenter market by attracting large international datacenter operators with significant investment capabilities.

The Take

Although the Romanian datacenter market is dominated by small local datacenter operators, the abundance of IXPs, a combination of terrestrial and submarine cables, the government's focus on digitalization, and other factors related to labor cost and corporate tax advantages could be important incentives for large operators to establish datacenter facilities in the country. Romania is seeing some early indicators of interest from both Amazon Web Services and Microsoft Corp., with both having made modest investments in the country already. However, the country is not without its challenges, which arise from an energy mix largely reliant on fossil fuel sources and the very low levels of digitalization of the economy.

Context

Romania joined the EU in 2008 and has a population of 19.29 million. Its territory is partially situated in the Balkan Peninsula, and the country shares borders with Ukraine and Moldova to the north, Hungary and Serbia to the west, Bulgaria to the south, and the Black Sea to the east. According to Eurostat data in 2021, Romania is the penultimate country of the EU in terms of GDP per capita, preceding only Bulgaria. The country has committed to joining the euro by 2027.

Although the country ranks last in terms of DESI score (Digital Economy and Society Index, formulated by the EU), the COVID-19 pandemic led to a breakthrough: On the one hand, it spurred the government to introduce legal changes and deploy new technologies that had been postponed, and on the other, it forced Romanian society to use digital services.

Today, Romania has some competitive strengths that could help develop Industry 4.0. According to the Country Report published by the European Commission in 2019, the IT sector in Romania is very developed, and the country has a highly skilled workforce in this sector. For example, in May 2021, AWS opened an office in Bucharest, following the AWS Development Center launch in 2018 and an Amazon CloudFront Edge location in 2020. The Development Center is home to AWS teams working on key technologies for the Amazon Elastic Compute Cloud (Amazon EC2) service. Similarly, in 2020 Microsoft launched the first artificial intelligence laboratory at the Bucharest Academy of Economic Studies, one of the country's largest economic higher education institutes.

McKinsey outlines that — with regard to telecom physical and digital infrastructure — Romanian telecommunication companies have invested continuously in their respective networks. As a result, the country is a European leader in terms of the share of ultra-fast broadband subscriptions in the country. According to Speedtest.net, in 2021 Romania ranked fourth in the global list of countries with the "fastest broadband internet speeds (232.17 Mbps), preceded only by Monaco, Singapore and Hong Kong.

In Bucharest, there are five IXPs. The Balkan-IX internet exchange holds nodes in two facilities, NXDATA-1 and NXDATA-2, the first neutral colocation datacenters in the country, which are owned and managed by local provider NXDATA. Romanian Network for Internet Exchange (RoNIX) is an IXP, a national infrastructure for traffic exchange between the country's telecommunication and service providers. Currently, RoNIX holds nodes in five datacenters in Bucharest (NX-Data-1, Ines DC, GTS, M247 and Teletrans). InterLan Internet Exchange (InterLan) is a neutral national interconnection platform for data traffic and internet exchange, with national points of presence in Bucharest, Constanta and Timisoara. NetIX — a partner of Bulgaria's largest telecom provider, Neterra — has a point of presence in Bucharest. NetIX is a global internet exchange platform with over 30 IXPs across 55 countries in six continents. DreamServer Internet Exchange is the fifth IXP in Bucharest.

From the point of view of the international exchange of data, Romania is connected to the major Central European markets and the Balkans via terrestrial cable networks operated by EXA Infrastructure, Turk Telecom and Telia Sonera. Additionally, the submarine cable landing in Constanta (Diamond Cable) ensures the exchange of data with the Caucasus region, while the other submarine cable landing in Magalia (KAFOS) ensures the international exchange of data with the Middle East via Varna (Bulgaria).

Despite the substantial presence of IXPs, terrestrial and submarine cables, and internet service providers, Romania's datacenter market is dominated by local operators with a small average size of facilities (5,271 sq. ft.). Indeed, the low levels of digitalization of the economy, including in the government sector, still make the Romanian market unattractive to foreign datacenter operators and hyperscalers. Global and continental datacenter operators like Equinix Inc., Digital Realty Trust Inc., NTT and Data4 have not invested in the country. However, a positive signal for the development of the data center market in the country was launched by domestic datacenter  operator ClusterPower, which recently announced the opening of the first Romanian hyperscale facility in a 273,400 sq. ft. campus that is expected to house five buildings. The ClusterPower Technology Campus will have a capacity of up to 4,500 racks and 200 MW.

Romania's recovery and resilience plan

Under the support of the Recovery and Resilience Facility set out by the EU following the outbreak of COVID-19, Romania requested €14.2 million in loans and €14.9 million in grants (approximately 13% of the country's GDP). According to the plan submitted by the Romanian government, 21% of the budget will be devoted to the country's digital transformation, and 41% of the budget will be allocated to support the country's green transition. This strategy, based on digitalization and green transition, is very relevant to the development of the datacenter market in the country.

On the one hand, the digitalization of the society, with the consequent increase in the production of digital data, is expected to drive additional demand for datacenter facilities. The digitalization of government services with the migration of public administration data to the cloud is also expected to attract hyperscalers in a market dominated by small local datacenter providers.

On the other hand, within the framework of the green transition, the plan to phase out coal and lignite power production by 2032 is likely to improve Romania's attractiveness for international datacenter operators committed to net-zero emissions, which choose the location for their facilities taking into account the energy mix offered by the country.

Strengths: Low corporate income tax and labor cost

As shown if Figure 1, in 2021 the labor cost per worked hour was one of the lowest in the EU. With an hourly compensation per worker of €8.5, the country's labor cost was 25% of the Euro Area average.

Figure 1: Hourly Labor Costs Per Worker in Industry, Construction and Services Except Public Administration, Defense, Compulsory Social Security (€)

Source: Eurostat

Romania's attractiveness for foreign direct investment is also enhanced by the low effective tax rateon large corporations compared with the EU average and the largest European economies. For example, in 2021 the effective tax rate on large corporations in Romania was 14.7%, much lower than France, Germany and Spain, the latter of which is one of the fastest-growing datacenter markets in Europe.

Figure 2: Effective Average Tax Rates, Large Corporations Outside the Financial Sector (%) 

Source: Eurostat

Weaknesses: Brown energy and digital deficiencies

The electricity market of Romania is significantly reliant on fossil sources. Indeed, a large portion of the country's energy mix is accounted for by coal and fossil fuels. The share of energy from renewable sources is approximately 25% of the total supply, substantially equal to Bulgaria (23.3%). 

Figure 3: Share of Energy From Renewable Sources

Source: Eurostat

The rest of the electricity supply comes from a mix of coal, oil and nuclear plants. Therefore, the extent to which Romania will be able to phase out carbon by 2032 will depend on the government's ability to effectively allocate the funding of the European Recovery and Resilience Facility.

Romania accessed the EU in 2007 with very low levels of economic development. Since then, the country has sought to leverage its low labor cost and corporate taxation to attract greenfield foreign direct investments and pursue export-led growth based on the traditional manufacturing industries within the European single market. Therefore, Romania has the lowest level of digital development in the EU. Indeed, the country ranks 27th of 27 EU member states in the 2021 edition of the DESI, with an overall score very similar to that of Bulgaria.

Figure 4: Digital Economy and Society Index 2021

Source: Eurostat

If we analyze the raw data and indicators that make up the overall score, we find that only 7% of the companies operating in Romania utilize the cloud (EU average 26%), and only 33% of the SMEs have a least a basic level of digital intensity (EU average 60%). Similarly, only 31% of the individuals have at least basic digital skills (EU average 66%). Furthermore, e-government users represent only 16% of the internet users (EU average 64%), and the digital public services for business score is half the EU average.

Outlook

The low levels of economic development and digitalization, the geographic location, and the reliance on coal, oil and nuclear plants still differentiate Romania from most Eastern European countries that joined the EU after 2004. Instead, Romania shares the same strengths and weaknesses as neighboring Bulgaria.

On the one hand, both countries have very low corporate taxes and labor costs. On the other hand, both countries are characterized by a large portion of the energy supply coming from fossil fuel sources and nuclear plants.

From the geographical point of view, both the countries border the Balkan Peninsula in the west and the Black Sea in the east, representing a potential connectivity gateway between Europe, the Caucasus and the Middle East. For these reasons, we see Romania and Bulgaria as competitors for the attraction of datacenter operators planning to serve companies operating in southeastern Europe.

Bucharest, the city capital of Romania, is only 45 miles away from the Bulgarian borders. However, the Bulgarian datacenter market is much more developed than the Romanian. Indeed, in Bulgaria global datacenter operators like Equinix and GTT operate beside large regional datacenter providers like Neterra. For example, India-based datacenter operator VueNow InfoTech signed a memorandum of understanding with Plovdiv Tech (90 miles from Sofia) to invest $12 million in building up to seven facilities in the country. At the moment, we do not see a relevant stance for the growth of Romania's datacenter market, and we think that — over the next years — the foreign investments in the datacenter industry will be disputed with neighboring Bulgaria. Assuming the latter is the main competitor for attracting foreign datacenter operators, the phasing out of coal by 2032 would give Romania a competitive advantage over its neighbor. Overall, the growth of the Romanian datacenter market will mainly depend on the country's ability to compete with Bulgaria for the attraction of global datacenter operators.