BUCHAREST - Romania, the European Union's second-poorest member, is crawling out of a deep recession after implementing austerity measures demanded in an International Monetary Fund-led economic bailout.
The southeast European country, where nearly 3 percent of the population live on $40 a month, had the fastest economic growth rate in the EU until a real estate and credit bubble burst in 2008.
Prime Minister Emil Boc resigned in February after nationwide anti-austerity protests and his successor, Mihai Razvan Ungureanu, has already been turned out by a no-confidence vote in parliament.
The leftist Social Liberal Union (USL) is now in government, seeking to maintain its high popularity ratings in a parliamentary election due in November.
Premier-designate Victor Ponta unveiled his cabinet on May 1, appointing politicians from his USL with a central banker as finance minister, and is expected to win parliamentary backing on May 7.
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, knocked the popularity of the ruling Democrat-Liberal Party (PDL) to less than 20 percent.
That has ended the mandates of two prime ministers and sent the PDL into opposition. The USL, a fragile leftist alliance that has committed to working with the IMF, now has a chance to form a new government and, with about 50 percent support, is set to consolidate its position in the election.
The political uncertainty of the last few months has sent the leu currency to an all-time low against the euro, which is particularly painful for the two-thirds of borrowers who have loans in foreign currencies.
What to watch:
– Will Ponta gain parliamentary backing for his administration? His proposed government will face a parliamentary vote of confidence on May 7.
Approval should lend support to Romanian assets and keep a lid on borrowing costs and the USL appears to have enough backing in parliament to stick around longer than the two months its predecessor managed.
But there are still questions over how closely a Ponta administration would stick to terms of the IMF agreement.
IMF BACKING
Romania has shown commitment to adhering to the terms of its IMF safety net, 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.
The country has a new deal with the IMF to replace a 20 billion euro ($26.5 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.
Romania will only draw on the 5 billion euros available under the new deal if needed.
While the IMF suspended a review of Romania last week when the government fell, Ponta and the USL have committed to maintain the deal, which helped to prevent the leu falling even further.
The deal is widely expected to remain in place once the new government is confirmed, t hough the USL may not want to stick to some of the longer-term measures like privatisation of inefficient state-owned companies, which could have a longer-term impact on the country’s potential.
The IMF has said Romania has some limited room to ease austerity by raising public wages or cutting a minor tax while still maintaining its fiscal deficit target.
The USL could also try and ease austerity in other areas, for example by raising pensions or cutting sales tax, which would keep markets on edge.
Demand for Romania’s debt plummeted and the cost of insuring it rose when the IMF deal was put on ice due to a political crisis in late 2009. Previous delays in payments also knocked the leu and blue-chip stocks.
What to watch:
– Whether the government maintains commitment to the IMF and to what extent it seeks to ease austerity – and the impact on the budget deficit – before the parliamentary election due in late 2012.
– The USL’s commitment to longer-term actions under the IMF deal, such as privatisations and deregulating energy prices, another major bugbear for investors.
EURO ZONE
While the economy has finally emerged from deep recession, consumption remains depressed. Romania remains particularly vulnerable to developments in the euro zone, its main trading partner.
Greek banks control about a sixth of Romania’s banking system and concern over the impact of the debt crisis sent the leu to 16-month lows in November and increased the cost of insuring Romanian sovereign debt.
The central bank has cut interest rates for the fourth time in a row since November to a record low 5.25 percent, taking advantage of slowing inflation.
The economy grew about 2.5 percent last year but that is expected to slow in 2012 and could even slip back into recession. The IMF expects the economy to grow by between 1.5 and 2 percent this year.
Annual inflation hit a new low in March of 2.4 percent, which may give space for the central bank to cut rates again, though it also needs to maintain a premium to safer assets to prevent investor flight.
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 Western 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 5.1 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 just 1.9 billion euros in 2011. It has to 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 benefit.
CORRUPTION
Failure to fight corruption since joining the EU in 2007 has undermined the economy and kept Romania out of the EU’s passport-free Schengen zone. Prosecutors have convicted some lawmakers, but most remain free pending a lengthy appeal process.
In January, the top court sentenced former Prime Minister Adrian Nastase to two years in jail for graft.
It also jailed a serving lawmaker for the first time, an indication it is getting more serious about cracking down on graft after pressure from Brussels.
What to watch:
– Whether Nastase, who remains free pending an appeal, actually goes to jail. Putting top-level politicians behind bars would send an important signal and boost the confidence of potential investors.
