BLACK SEA BLOG: Romania at risk of botching "the lesser of two evils"

By bne IntelliNews June 8, 2010

Bogdan Preda in Bucharest -

With Finance Minister Sebastian Vladescu admitting that "we cannot lie for another six months" just to buy some more time "to see what happens," it seems Romanian politicians have at last accepted they have no choice but to make painful changes to narrow the country's deficits or risk bankruptcy. But are they capable of carrying through the reforms that have been decided on?

The choice in early May was to either increase the flat income tax from 16% to 20% and the VAT to 24% from 19%, as the International Monetary Fund (IMF), Romania's main creditor nowadays, reportedly recommended, or to cut social spending and public sector pay. The government chose the second option, which it described as "the lesser evil," and in doing so argued that raising the main taxes would have hit the private sector hard, the only thing keeping the economy running right now; equally, it would have discouraged foreign investment. A higher VAT was also expected to push inflation back into double-digits, the central bank rightly argued.

Hence, in the most drastic economic action since the fall of communism more than 20 years ago, the government decided to slash a quarter of the salaries of its 1.4m government employees, reduce state pensions by 15%, and also partially or entirely cut other forms of social spending including child-care allowances. Additional actions include starting to tax interest rates on almost any kind of bank deposits from zero to 16%, tax foreign-exchange operations, tax additional house ownership and much more. The measures, especially the wage and pension cuts, have already stirred massive social unrest in the country, with teacher, transport and healthcare trade unions staging partial strikes, disrupting public transportation and school classes.

Romania, which thus far has received about half of its €20bn "emergency loan" from the IMF, the EU and the World Bank (with the IMF being the main donor under EU monitoring,) will get the next disbursement of about €900m only if it implements the "austerity measures" that President Traian Basescu and Prime Minister Emil Boc have already announced. Since trade unions and company owners failed to reach an agreement with the government on alternative measures, the only relatively quick option that PM Boc has is to seek a confidence vote in parliament. That's scheduled to take place on June 7, and the PM is likely to win that round.

Bad track record

However, as the track record of previous governments shows, Romania's biggest problem won't be its trade unions or social unrest, but its inability and lack of accountability in implementing the decisions it sets out. In other words, the biggest threat could soon be that of the government failing to put the right budget-monitoring and tax-collection policies in place in order to make the cuts work.

That would mean eventually resorting to the hikes in its main taxes that it's now saying it won't introduce. That would be close to a disaster both internally and from the point of view of investor confidence, because it would hit the population and the country's chances of a recovery not just once, but twice. And it would all again be the result of mismanagement. If anything like that happens, another government resignation wouldn't solve anything.

The government is counting on the fact that the new painful economic measures will help it save about €2.5bn by the end of the year, thus narrowing the budget gap from 7.9% to 6.8% of GDP. It also counts on more money from such measures in the years to come, but only mathematically, while failing to also prepare sound economic and social policies that would help increase productivity.

For one thing, the government is avoiding putting a number on how much it expects to get of the €32bn it's entitled to get for free from the EU accession funds through 2013 if it puts in place the right projects. Since it joined the trade bloc in 2007, the country has managed to draw no more than slightly more than 2% of the amount of EU funds it's due, with the government complaining that banks are reluctant to lend the amounts needed by project developers to match the disbursements from the EU.

Although the global economic crisis had barged through Romania's doors by the middle of 2009, the contenders in the December presidential elections turned a blind eye to its consequences for the sake of either gaining or consolidating their political power and, hence, business-making positions. So they kept promising voters that the crisis wouldn't hit Romania as badly as other countries, while all the time promising to maintain an bloated and expensive civil service.

Now the time of beauty politics is over and the invoice is overdue. Ruling politicians such as President Basescu have started talking about an imminent need to cut as many as 200,000 such government jobs to ease the burden of private sector taxpayers. But this is happening all of a sudden and people aren't ready to understand the seriousness of the economic downturn after having been told so many times that the situation is manageable.

The truth is, the situation is far from being manageable without better tax collection, accompanied by real and sound economic boosters. As the central bank governor, Mugur Isarescu, recently pointed out, Romania now has 1.4m employees being paid directly from the state budget, compared with about 900,000 when it broke with communism in 1989. That's odd when one realizes that the country's population then was almost 23m, while now it's fallen below 20m. It's also strange given the fact that about two-thirds of the economy is privately driven, as opposed to being 100% owned by the state as was the case more than 20 years ago.

The fact is that neither Romanians nor their government are prepared to deal with such hard times after having enjoyed economic growth for almost nine consecutive years. Even a miracle would need to be very carefully managed, if it ever showed up. One way or the other, the economic correction will be brutal and the consequences too many to predict at this point in time. One thing is clear: Romania won't be able to overcome its many problems in the next six to 12 months without help from outside.

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