IHS Global Insight Perspective | |
Significance | Romania will receive access to a 2-year, 20-billion-euro loan package led by the IMF. |
Implications | Without this facility, the country would face a very severe macroeconomic adjustment, as it proved unable to finance its external payments and fiscal deficits. |
Outlook | The economy will nevertheless contract quite sharply in 2009 in the face of the global economic recession, but if the government can deliver on the IMF's required policy programme it will brighten prospects for the medium term. |
Following the cabinet's approval of a letter of intent on 25 March, Romania is to become the fourth economy in Emerging Europe and the third in the European Union (EU) to agree on a credit facility from the IMF to support its balance of payments. The IMF has facilities in place for Latvia, Hungary and Ukraine. The two-year plan, outlined yesterday, totals 20 billion euro (US$26.9 billion). Of this amount, the IMF itself is to provide 12.95 billion euro, the EU another 5 billion euro, and the World Bank 1 billion euro. In addition, the European Bank for Reconstruction and Development (EBRD) has pledged to invest 1 billion euro in Romania over a 2-year period. The IMF board will meet on 4 May to approve the arrangement, while similar approvals will be required from the European Commission and the World Bank's executive body. The EBRD has plans to invest one-half of its sum in Romania's financial sector, and the other half in a broad range of undertakings, including investing in private-sector corporations, and increasing Romania's competitiveness via infrastructure investment.
While the facility was much needed to prevent a looming crisis of confidence in Romania, due to its persistently large current-account and fiscal deficits amid an increasingly gloomy external economic picture, the IMF does not expect that it will help Romania avoid a substantial contraction of economic activity in 2009. In fact, in its most recent assessment, the IMF foresees a decline in GDP of 4% in 2009. Previously, the Romanian government under Prime Minister Emil Boc had promoted a relatively austere budget for 2009, by Romanian standards, with a deficit of 2% of GDP, compared with the 5.2% sustained in 2008 that was to help trim the country's financing needs sufficiently to weather the global economic storm without a sharp macroeconomic adjustment. However, the assumptions of that budget were far too optimistic, and investors increasingly began to lose confidence in the Romanian economy and currency. The leu has taken a substantial beating in recent months, exacerbating the problems of domestic entities heavily burdened with foreign-currency denominated debt. In early March it became clear that Romania would have to turn to the fund and the EU for assistance, or face a real crisis not too far down the road.
As usual, the facility will be conditioned on adherence to an agreed economic policy programme. Recognising that the Romanian economy is likely to contract quite sharply in 2009, heavily denting fiscal revenues while placing a greater burden on the budget from social support measures, the IMF has agreed to a fiscal deficit this year of 4.6% of GDP, well above what might have been expected. At the same time, the IMF is asking for fiscal reform aimed at taming deficits going forward. Both the IMF and the EU have made it clear that they expect Romania to move towards a deficit within the Maastricht limit of 3% of GDP by 2011. The IMF will require Romania to improve the transparency of its budgeting process and adopt a multi-year framework for planning purposes. Romania will be required to alter its incomes policies, reining in the growth of relatively high public-sector salaries and state pension payments. Financial controls on state-owned enterprises will have to be tightened, and efforts redoubled to reduce the burden of their subsidisation on the budget. Lastly, Romania will be expected to meet the National Bank's end-year inflation goal with the rate falling within a 1% band on either side of the 3.5% goal. The IMF also stated that it will be necessary to obtain the co-operation of the foreign parent banks of Romanian subsidiaries that dominate the banking sector in order to ensure that they are willing to maintain the ability of their daughters to sustain domestic lending.
Outlook and Implications
The IMF-led loan package should provide the Romanian economy with some welcome relief. It should help to stabilise the currency by beefing up official foreign-currency reserves, as well as ease the process of macroeconomic adjustment by sustaining credit availability for domestic enterprises and consumers. Should the government be able to deliver on the economic policy prescriptions, this would be a major plus for Romania, as it will be able to emerge from the current bleak situation with far better prospects for assuming the path to the Eurozone. A relatively sharp recession in 2009, however, can not be avoided, given the collapse in export performance and the badly dented confidence and purchasing power of domestic enterprises and consumers.
The question of delivering on the agreed policy programme is a very important one, however. Romania has a very poor record on keeping its end of bargains with the IMF. Only one of seven IMF programmes since 1989 have been successfully completed; they have often been derailed by the requirement to surrender to the demands of powerful public-sector labour unions. In fact, the unions are likely to prove a harder negotiation partner to the government than the IMF itself. They have already held a strike against the effective freeze in public-sector salaries and bonuses that Boc's cabinet imposed. The unity of the government itself will be tested, as the coalition partners of the ruling Democratic Liberals (PDL), the Social Democrats, may seek to outdo the PDL at the presidential election in November or December this year, by appealing to the spending inclinations of the electorate. Finding consensus domestically would be a hard sell for Boc, and he is best advised to follow the IMF recipes and programme without referring to them as such, but trying to find some new incentives for the electorate to pull through the new stage of reform. Part of this could be greater enjoyment of EU-membership benefits, after years of the population's suffering for the end. This, in turn, is dependent upon Romania's compliance with legal transparency and the rule-of-law criteria of the EU; the fight against corruption may provide a much-needed unity ground with the trade unions.