There is huge global uncertainty ahead. Can Romania do anything about it?
Adresa
Bulevardul Barbu Vacarescu, Nr. 301-311
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020276 Bucureşti, Sector 2
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+40-21-319.11.69
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www.rbs.ro
The global economy has entered a new stage of the economic and financial crisis that began in 2007-08, after the initial state intervention intensified the sovereign debt problem for countries that were already highly indebted.
Europe and the United States are the most exposed, with the Euro zone’s lower fiscal integration, significant discrepancies between member states’ debt problems and the diverging opinions of Euro zone decision makers regarding a resolution putting Europe in a worse position than the US. Moreover, austerity plans announced by different European economies lead to a greater likelihood of recession in 2012 for this continent. In the US, besides the fiscal deficit adjustment measures, a plan to sustain the economic recovery and stimulate employment has been proposed by President Obama, but continued fighting between Democrats and Republicans can put in danger the implementation of such a programme.
It is more than obvious that Europe needs a concentrated and coordinated action plan to cope with the sovereign debt crisis with the epicentre in Greece. At least that is what investors are asking for. The markets have already penalised the European authorities’ slow reaction. Greece is one insolvent economy and the default is unavoidable – what is important is whether or not it will be a controlled default inside the Euro zone. EU officials are signalling that a scenario with a haircut of 50-60% for Greek sovereign debt is on the table (assuming Greece remains in the Euro zone). If such a level of haircut for the insolvent debt will become effective and moreover the Euro zone enters into recession, the recapitalisation needs of European banks couldrise to around EUR 250 bn – according to scenarios issued by different international institutions (i.e. 2% of Euro zone GDP, quite manageable if the effort is coordinated). Europe is getting closer to putting together a plan to address the problem of confidence in the Euro zone’s banking sector, but until it is ratified along with a medium and long term strategy to provide stability and growth – the only solution to manage the debt problem in time – Europe might be further penalised.
Romania’s economy performance remains highly dependent on foreign capital inflows, as its internal resources have never been enough to push the economy forward (for example, government revenues have never surpassed the level of 33% of GDP, the lowest in the EU, while the misallocation of expenditures is another issue). More recently the growth performance has become increasingly reliant on external demand. Even Romania’s foreign direct investments have significantly declined since 2009, a phenomenon widely spread across Central andEastern Europe. But this should not be an excuse – Romania had European structural funds at its disposal to compensate unfavourable dynamics, funds that are still available to some extent. Between 2007 and July 2011 Romania has absorbed EUR 2.5 bn (0.55 bn on average per year) from the EU structural funds, just 13.25% of total allocations for 2007-2013 (8 pp upfront payments and 5 ppdisbursements). This is the lowest absorption rate seen in the EU, with the worst performance seen in the transport programme (3% absorption). A look at the various contracts that are using EU funds show that EU co-financing covers only 62% of the total value of projects (on average), the worst coverage being seen again in the transportation programme (only 40%) due to high non-eligible expenditures. So under the contracts approved, the domestic financing needs are significantly high. In the transportation sector, assuming that the government is the beneficiary of most projects, the state contribution towards co-financing is not 15%, but much more (it could reach even 50%-60%). As Romania was in a fiscal adjustment programme, and still is, and even though co-financing would be reduced to 5% from next year (a project that still has to be approved by the European Parliament), financing non-eligible expenditures from the public budget remains an issue in the case of public beneficiaries. One solution could be the privatepublic partnership in order to transfer part of the financing to the private sector – but then the question of whether the financing sector will be able to cover these needs arises, with confidence in the global environment relevant here. Not to mention that continuous reforms of public administration are needed – improved funds allocation (efficiency is the key word), better revenue collection and so on. Things have been done in this direction recently (for example, the renegotiation of road construction contracts to obtain lower costs, the appointment of a Minister of European Funds, and a slight improvement in revenue collection), but Romania needs to accelerate its efforts in order to maximise the opportunity of absorbing EU funds. It is not easy to absorb free money, but because they have this quality, in such a difficult global context (withgetting financing much harder), Romania should focus more on absorbing them.
Separately, there is a programme hatched by the Ministry of Development to allocate infrastructure projects to the value of EUR 3-4 bn that will be financed in the first two years by developers and from 2013 the new government will pay for the projects until 2020. One possibility for constructors to get financing is to obtain loans from credit institutions under a letter of guarantee granted bythe state-owned Eximbank. Then the question arises of whether the banks will engage in such deals. The idea of postponing some capital spending beyond the IMF-EU agreement’s expiry and elections is questionable as it might be possible that the funds allocated for 2011-2012 will have to be included in the ESA deficit (in fact all these ultimately imply a government commitment, through indirect guarantees for example). And the next governments will have the money to pay and finish those projects or will remain in the air? This kind of project management is spreading uncertainties, as it implies an unknown government and spending possibilities. Another important issue to address is the reform of Romania’s state-owned enterprises. Their arrears (4-5% of GDP) weigh on the economy as a whole, from the fiscal performance to the performance of the private sector. The fact that some are loss makers is another problem, with restructuring remaining the solution. Replacing existing management withprivate management could be seen as a step forward except the case it would be just a cosmetic move and would not imply also a real reform of the respectivecompanies. In addition, the government wants to sell minority stakes of some state-owned companies (particularly in energy and transportation) but unlessthe energy sector is freed up and companies become profitable, there will be no interest for investors to hold a minority stake, as a minority shareholderwould have no decision-making power. The fiscal deficit target for this year (4.4% of GDP, cash basis) looks reachable, but next year’s target (3% of GDP, on an ESA 95 basis, meaning even a lower deficit in cash basis) is at risk as firstly it was setduring a period of higher economic growth and after the enclosure of some SOE losses in the budget. If deviations from the target occur due to external factors, we believe that the supranational institutions might be flexible – unless the slippages will be the result of government policy. We expect next year’sfiscal deficit to be at least 3.5% of GDP (cash basis), as our economic growth assumption is lower – and it could be even higher if global growth assumptionsprove overly optimistic. As 2012 is an election year, it would be hard to see the government changing taxes to obtain more revenues. On the other hand, no important tax relief should be expected as Romania is still in an adjustment programme.
Separately, there is a programme hatched by the Ministry of Development to allocate infrastructure projects to the value of EUR 3-4 bn that will be financed in the first two years by developers and from 2013 the new government will pay for the projects until 2020. One possibility for constructors to get financing is to obtain loans from credit institutions under a letter of guarantee granted by the state-owned Eximbank. Then the question arises of whether the banks will engage in such deals. The idea of postponing some capital spending beyond the IMF-EU agreement’s expiry and elections is questionable as it might be possible that the funds allocated for 2011-2012 will have to be included in the ESA deficit (in fact all these ultimately imply a government commitment, through indirect guarantees for example). And the next governments will have the money to pay and finish those projects or will remain in the air? This kind of project management is spreading uncertainties, as it implies an unknown government and spending possibilities. Another important issue to address is the reform of Romania’s state-owned enterprises. Their arrears (4-5% of GDP) weigh on the economy as a whole, from the fiscal performance to the performance of the private sector. The fact that some are loss makers is another problem, with restructuring remainingthe solution. Replacing existing management with private management could be seen as a step forward except the case it would be just a cosmetic move andwould not imply also a real reform of the respective companies. In addition, the government wants to sell minority stakes of some state-owned companies(particularly in energy and transportation) but unless the energy sector is freed up and companies become profitable, there will be no interest for investors to hold a minority stake, as a minority shareholder would have no decision-making power.The fiscal deficit target for this year (4.4% of GDP, cash basis) looks reachable, but next year’s target (3% of GDP, on an ESA 95 basis, meaning even a lower deficit in cash basis) is at risk as firstly it was set during a period of higher economic growth and after the enclosure of some SOE losses in the budget. Ifdeviations from the target occur due to external factors, we believe that the supranational institutions might be flexible – unless the slippages will be theresult of government policy. We expect next year’s fiscal deficit to be at least 3.5% of GDP (cash basis), as our economic growth assumption is lower – and itcould be even higher if global growth assumptions prove overly optimistic. As 2012 is an election year, it would be hard to see the government changing taxes to obtain more revenues. On the other hand, no important tax relief should be expected as Romania is still in an adjustment programme.
