Romania’s recovery trajectory
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Mai 2011 |
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GABOR HUNYA - Senior Economist
THE VIENNA INSTITUTE FOR INTERNATIONAL ECONOMIC STUDIES (wiiw) |
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GABOR HUNYA
Senior Economist
THE VIENNA INSTITUTE FOR INTERNATIONAL ECONOMIC STUDIES (wiiw)
Summary
After two years of contraction, the economy in Romania will start to recover in 2011. A return to the pre-crisis boom is impossible owing to constrained external financing; however, a mini-boom can be expected in the election year 2012. In all likelihood, this will be followed by a new wave of fiscal stabilization and growth deceleration. Drivers of this economic cycle are already visible in the current government plans, but the actual magnitude of economic growth will hinge on the economic policy selected and the response of the capital markets.
Austerity caused delay in recovery
The 2009-2010 contraction of the Romanian economy was one of the deepest and longest lasting in Europe. The austerity measures introduced in mid-2010 additionally suppressed domestic demand and caused more than 1% contraction of GDP for the year as a whole. Wage cuts in the public sector and a 5 percentage points VAT increase resulted in a 4% decline of net real wages and private consumption. The reason behind these measures was the fear of fiscal un-sustainability in line with the IMF-led programme put in place in May 2009. This aimed at curtailing the budget deficit to GDP ratio by improving the fiscal balance and taking GDP contraction as a side effect. It is quite natural, that lower public demand leads to lower GDP and therefore more fiscal austerity is necessary to achieve the deficit/GDP target. While the IMF-led programme saved the country during spring 2009 when it faced a liquidity crisis, this financial buffer allowed postponing structural adjustments. Two thirds of the programme money financed directly the budget deficit thus the government could avoid cutting expenditures and getting exposed to market financing. The relief provided in 2009 was really necessary but it should have been connected with structural reforms. Those reforms were postponed, some of them to 2010, many of them to 2011 or later. None of the three governments of the past two years has been able to come up with a credible fiscal and development programme and economic policy making was essentially shifted to the IMF. Due to the lack of reforms in the first half of 2010 the deficit to GDP indicator worsened. There was also no trust in the recovery which was incepting based on foreign demand. Therefore the fiscal adjustment in mid-2010 was extremely harsh and not well prepared. In light of more recent developments it turns out that the austerity measures suppressed demand more than necessary, extinguished recovery and overshot the deficit target*.
As a result of the fiscal measures, private and public investment activity remained very much suppressed in 2010; gross fixed capital formation fell by about 15% after a similar contraction rate in the previous year. But stock building increased considerably compensating the effect on gross capital formation, thus the latter had a largely neutral effect on GDP growth. Investments in buildings remained at a very low level, residential construction and the issuance of building permits continued to decline, while machinery investments recovered close to previous year’s level. Net exports made a positive contribution to the change of GDP due to strong export demand. The corporate sector split between the successful exporters and related suppliers and those trying to sell to local customer. Payment arrears have disrupted the functioning of SMEs and the number of bankruptcies increased three-fold mostly affecting trade and construction.
Unemployment and inflation stay above target
The unemployment rate has risen to about 7.4% (LFS end of 2010) – back to where it was four years ago, which is still low in international comparison. A main reason for the relatively low unemployment is the high employment level in public services and the generous labour protection legislation causing labour market rigidity. In order to economize on public funds labour market and social benefit reforms are being introduced. Public sector employment was cut already in 2010. Measures becoming effective in 2011 are due to increase labour market flexibility and may result in higher unemployment on the short run. On the medium run the new labour code may support investment and increase efficiency.
The tax surge drove end-2010 inflation up to 8% (the highest rate among NMS), still inflation has so far not been considered a problem by the National Bank. The policy rate was reduced in May to 6.25% and has been left unchanged ever since. Major fluctuations of the exchange rate were avoided in 2010 by market interventions which kept the annual average close to pre-year level. The effects of the VAT hike will continue in the first half of 2011, and also higher international commodity prices will exert additional inflation pressure. As a result, the average CPI may not come down below 4% even in 2012. There are signs that the National Bank acted against inflation by interfering on the forex market and strengthening the currency. When looking at the fundamentals one has the impression that the exchange rate of about 4.3 RON/EUR is feasible but diversions are highly possible due to investors’ decisions.
External financing constraints marginally soften
Romania underwent a serious external re-balancing in the past three years in which depreciation and domestic austerity both had their roles. The advantage of exchange rate flexibility is remarkable if compared to fixed-rate Bulgaria, where the whole adjustment had to be born by internal depreciation. The Romanian current account balance worsened slightly in nominal EUR terms in 2010. The goods trade balance improved but all other items worsened. The deficit of the incomes account increased both due to higher interest payments and profits of foreign investors, trends which may persist on the medium run. The surplus of the current transfers, 4.3% of GDP in 2009, declined to 2.8% of GDP in 2010 meaning that Romanians working abroad transfer home less during the crisis. On the financial account FDI declined but portfolio investments and shortterm capital inflows recovered. The main sources of foreign inflows were funds from the IMF and other multilateral institutions.
There is a lot of uncertainty concerning the future economic trajectory. The two-year agreement with the IMF is expiring and the question is what to put in its place thereafter. The new precautionary accord with a fund of EUR 3.5 bn from the IMF, EUR 1.4 bn from the EU and EUR 0.4 bn World Bank projects will span for two years from May 2011. This new agreement may provide some safeguard but will put a much weaker constraint on fiscal policy than the outgoing regime. Meanwhile, in order to finance the maturing loans, the government has to be more active on international financial markets where the country has little exposure. The lack of a track record can be a handicap. There are also plans for selling minority shares of state-owned companies included in the property restitution fund listed on the stock exchange. This can have positive effects both on the corporate governance of the effected companies and on the liquidity of the stock exchange. Improving efficiency of the state-owned enterprises which currently carry losses and eliminating the payment arrears can be part of the conditions of the new IMF agreement and will be supported by new programmes of the World Bank. Public sector inefficiency has been a recurring problem for twenty years and there have been several international programmes supporting related reforms. It is worth trying again and again.
On the whole, there has been growing confidence in Romania’s fiscal stability in the past few months. The five-year CDS-spreads moved together with those of Hungary until the end of November 2010 when both were about 300 basis points. The two countries disconnected later on with Romania staying flat and Hungary’s CDS increasing. The new Hungarian government disregarded international expectations after coming to power in May 2010, returning to a stability-oriented reform agenda only March 1st, 2011. Romania’s IMF-led programme has been valued as a success and the fiscal plan for 2011-2012 is considered sustainable. In January/February 2011 the ratings of both countries were improving and Romania continued faring better.
The 2011 recovery we expect to be a bit more robust than the majority of forecasters**. It will be supported by the one-time effect of the economy emerging from a very low base. Both consumption and investments start to recover. Public sector wages were raised in February partially compensating for the cuts of last year and also private sector wages are bound to recover. The government has a number of investment plans, especially in infrastructure, most of them to be financed from EU structural funds. We expect the current account deficit widen again as domestic demand picks up facilitated by the inflow of foreign currency and high forex reserves.
Election cycle ahead
For the coming years wiiw forecasts an election cycle. We expect that the government will not stick to fiscal and wage restraint when approaching parliamentary elections in late 2012. The result can be stepped-up GDP growth of about 4% in the election year. This will necessarily be followed by corrections in 2013 which will result in a lower GDP growth rate. Compared with the autumn 2010 forecast of the Romanian government3*** which is shared by the IMF we expect a somewhat faster recovery in 2011 and slower growth beyond 2012. We do not see the potential for extraordinary improvements in productivity and competitiveness in the medium run. Any growth of domestic demand above 3% will trigger a worsening of the external balance which in turn suppresses GDP and may hit financing constraints.
In support to our moderate boom-bust growth scenario we also refer to earlier experience. In the previous two election years 2004 and 2008 consumption growth was much higher than in the preceding and subsequent year. This will likely happen again but this time conditions will allow a smaller amplitude. First of all, the country’s external financing capacity is more restricted in the wake of the financial crisis. It has to rely on market financing in the case of public debt whereas private sector financing is more expensive and less readily available than before the financial crisis. At the same time,public debt is still relatively low leaving room for short term fiscal expansion.
*
Research for this article was completed in February 2011.* Only the cash deficit of the budget is available, not those calculated according EU-definition which may be higher.** Consensus Economics, Eastern European Consensus Forecasts, Survey data February 21st, 2011,*** Comisia Nationala de Prognoza: Prognoza pe termen mediu 2010 - 2014 – varianta de toamna 2010. November 5th, 2010
