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Key political risks to watch in Romania

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Aug. 3, 2012, 11:22 a.m. | World — by Reuters

In this file picture taken on July 3, 2012 Romanian President Traian Basescu delivers a speech at the Cotroceni palace in Bucharest. Romania's top court on August 2, 2012 delayed to September 12 its ruling on an impeachment vote against president Traian Basescu, a surprise move that could deepen the political crisis.
© AFP

Reuters

BUCHAREST - Romania, the EU's second-poorest member state, is clawing its way out of a deep recession after implementing austerity measures required by an International Monetary Fund-led bailout.

The southeast European country, where nearly 3 percent of the population live on $40 or less a month, had the fastest economic growth rate in the European Union until a real estate and credit bubble burst in 2008.

A new leftist prime minister, Victor Ponta, of the Social Liberal Union (USL), is embroiled in a bitter dispute with the centre-right semi-executive President Traian Basescu which has delayed policymaking and hit markets.

Basescu is unpopular for his links with austerity policies, which Ponta is seeking to ease to maintain his party's high popularity ratings ahead of a parliamentary election due in November.

Below are the main political risks for Romania:

GOVERNMENT STABILITY

Austerity measures taken in 2010, including a 25 percent cut in public sector pay and a 5 percent VAT rise, reduced the popularity of the then-governing Democrat-Liberal Party (PDL) - with close links to Basescu - to about 15 percent.

Austerity has ended the mandates of two prime ministers and sent the PDL into opposition. The USL, a fragile leftist alliance with about 50 percent support that has committed to working with the IMF, did well in local elections in June and looks on course to consolidating its position in the parliamentary election.

But its three months in power have been dominated by a bitter battle with Basescu and the USL has been hit by charges of plagiarism against Ponta, which he denies, and the jailing of former Prime Minister Adrian Nastase, whom Ponta has described as a mentor, for corruption.

Parliament suspended Basescu and Ponta had a severe dressing down from the European Union over his efforts to ensure the president was impeached in a national referendum on July 29, a row which set the leu tumbling.

Basescu appeared to have survived as turnout was below the 50 percent level the Constitutional Court ruled was required for the vote to be valid.

But now the spat is set to run for months, as the court will not rule on whether the referendum should stand until Sept. 12 because of confusion over the size of the electorate, and may further delay policymaking and pressure the currency.

The political uncertainty of the last few months coupled with concerns over the fallout from the euro zone, Romania's biggest trade and banking partner, sent the leu currency to an all-time low against the euro - particularly painful for the two-thirds of borrowers who have loans in foreign currencies. Government borrowing costs have also risen.

What to watch:

- Will the suspended Basescu be able to resume his duties and if so, can he and Ponta work together? While the president can only delay legislation rather than block it, the bad feeling is so deep rooted that the sniping is bound to continue and will further pressure Romanian assets.

- How much support has the USL lost due to recent scandals and its arguments with Basescu? Failing to impeach the president - despite winning a large majority of those who cast ballots - could reflect badly on its record.

The party scored more than 50 percent in June's local elections and needs to maintain that to be sure of a majority in November. Anything less than this would raise doubts over who will govern the country, since the president appoints the prime minister.

IMF BACKING

Romania has shown commitment to sticking with the IMF, pushing through unpopular measures to bring down its budget deficit to 3 percent of GDP in 2012, and still needs that backing to maintain investor confidence.

When an IMF deal was put on ice due to a political crisis in late 2009, demand for sovereign debt plummeted and the cost of insuring it rose. Previous delays in payments also knocked the leu and blue-chip stocks.

The country has a new agreement with the IMF to replace that 20 billion euro ($24.5 billion) bailout, reassuring investors it is still committed to fiscal reform, and it met a target of a 2011 budget gap of 4.4 percent of GDP.

Ponta and the USL have committed to maintaining the new 5 billion euro IMF deal, which helped prevent the leu falling even further, and have reached an agreement with its lenders to raise salaries to pre-austerity levels.

But the budget gap only just reached its first-half target and it tends to widen in the latter part of the year, particularly during election campaigns.

The recent political bickering has delayed and raised doubts over how closely Romania will stick to the terms of the deal, which was the main reason for the sharp decline in Romanian asset prices.

The USL may also not want to stick to some of the longer-term measures such as the privatisation of inefficient state-owned companies, which could have a longer-term impact on the country's potential.

It has said it aims to cut income and sales taxes should it win the November parliamentary election and while such measures may help the economy, they may also keep markets on edge.

What to watch:

- Whether the government maintains its commitment to the IMF and to what extent it seeks to ease austerity, and the impact on the budget deficit, before the parliamentary election.

- The USL's commitment to longer-term actions under the IMF deal, such as privatisations, healthcare reform and deregulating energy prices, another major bugbear for investors.

EURO ZONE

Domestic consumption remains depressed and the economy, which was recovering only slowly, slipped back into another recession in the first quarter. Furthermore, Romania remains particularly vulnerable to developments in the euro zone.

Greek banks control about a sixth of Romania's banking system and concern over the impact of the debt crisis has added pressure to the leu and increased the cost of insuring Romanian sovereign debt.

The central bank made four successive 25 basis point cuts in interest rates since November to a record low 5.25 percent, taking advantage of slowing inflation, but has since paused because of the slide in the leu.

The economy grew about 2.5 percent last year but slipped back into recession in the first quarter, though analysts expect it to rebound and expand about 0.8 percent for the year overall.

The annual inflation rate is expected to rise from 2.0 percent in June. A bumper cereal harvest in 2011 helped to keep prices under control but is unlikely to be repeated this year.

What to watch:

- Whether euro zone parent banks start reducing their credit lines. Analysts say the government and central bank have the resources to cover the gap, but it would stretch resources and could pressure asset prices.

SMALL LABOUR FORCE

Romania's biggest long-term challenge is stemming the flow of its workers, many of them young, to richer West European countries. Initial census data showed the population fell 12 percent in a decade to around 19 million.

There are only about 5 million employees paying taxes and most of the rest are pensioners, children, subsistence farmers or people working illegally. The inefficient, oversized state sector is also a drain on public finance and accounts for nearly a quarter of employees.

While unlikely to move markets, the long-term demographic problem - if not addressed - will keep a lid on growth.

Unemployment is 4.6 percent but analysts say the true number of jobless is higher because the data does not include those no longer eligible for benefit.

What to watch:

- Romania urgently needs more foreign investment, which was worth just 1.9 billion euros in 2011. It must cut bureaucracy and encourage banks to lend to people wanting to set up small companies if it wants to defuse a demographic timebomb.

- It could also cut pensions and public sector jobs, but governments are likely to shy away from such unpopular measures that will yield only long-term benefits.

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