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You're reading: Key political risks to watch in Romania

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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