BLACK SEA BLOG: Romania returns to "junk" 2 years after EU accession

By bne IntelliNews November 5, 2008

Bogdan Preda in Bucharest -

Maybe punching Romania back down to its 2005 "junk" status just two years after it joined the EU was a bit low. But that's precisely what Standard & Poor's did on October 27, when it downgraded the country's foreign debt rating to the lowest of any EU-member country, singling it out as the only one below investment grade.

In a normal world and under normal circumstances, S&P's exercise would have made a lot of sense. But with the whole world in crisis, the only effect the downgrade should have on Romania is that of a cold shower. Although rushed through by S&P, this cold shower is surely needed to wake up Romania's politicians before it's too late.

For the sake of being fair, though, let's first note that the S&P that downgraded Romania from the lowest 'BBB-' investment-grade rating back down to high-yield 'BB+' is the same S&P that failed to downgrade 'AAA' investment banks before they went bust back at home in the US as a result of the spiralling effects of the sub-prime crisis. So, how come can they see so clearly in the case of Romania if they didn't see what was going on in their own backyard?

Among reasons for the downgrade that S&P cited were the lawmakers' splurge preceding legislative elections due November 30. In approving amazing wage increases as high as 50% for nearly half a million teachers and other education personnel, they ignored the financial crisis that had now reached Romania and repeated calls by the central bank to contain spending by limiting salary increases.

Looking at the Romanian economy's main indicators today, S&P's hasty downgrade may seem unwarranted. But what S&P is actually saying is that such populist measures, passed by lawmakers belonging mainly to the leftist opposition plus some others from the governing parties sweating to grab some finish-line votes, are actually going to push the economy into a trap, as it is too fragile and private companies too indebted to withstand such moves at a time of crisis.

Even though biased by comparison with ratings awarded to other economies or entities in the region, coldly put: S&P is right. After all, why would increasingly reluctant foreign investors flock once more at Romania's door in 2009 to plough in their money at the same pace as before? The way these legislative elections look, with no clear winner and, again, no prospects for a government backed by a strong majority that could stick to a solid governing plan for the next four years, it's all quite depressing. And S&P's downgrade is a warning of those facts.

Playing S&P down

The more serious lesson to be taken from S&P's recent downgrade is that Romania's politicians appear to have learned nothing at all. Every party involved in the electoral process is playing down the rating cut either by trying to depict a different situation or by simply maintain their promises of more spending. This is providing a lot of leeway to people like the education trade unionists, who are taking advantage of the election campaign to stage strikes and threaten more if Prime Minister Calin Tariceanu's government doesn't immediately increase their wages rather than wait until next year.

On the other hand, government authorities and company owners estimate that close to 17,000 workers in the textile and furniture industries may lose their jobs even before the end of this year due to a lack of orders from abroad triggered by the financial crisis. Arcelor Mittal's Romanian steel plant is also planning layoffs, while Renault's car plant in Romania has already started to cut back on shifts and overtime due to a fall in orders.

Yet most politicians keep making promises as if Romania was part of some other world and they were the cooks of some magic recipes. True enough, there are recipes around, although no politician likes to bluntly talk about them during an electoral campaign. Take, for example, a measure first murmured by Ion Iliescu, an ex-communist minister and former president of Romania, the leftist Social Democratic Party's eminence grise, that his party is considering returning to a progressive personal income taxation system instead of the current flat corporate and personal income tax of 16%. Before losing power in 2004, the Social Democrats' government taxed corporate income at 25% and personal income by as much as 40%. A return to that system could in theory balance the wage spending, but it would also put an end to taxpayers trust in any continuity in governmental fiscal policy, as well as further dwindle confidence that the few remaining foreign investors still have in the Romanian economy.

As if this political brouhaha and electoral confusion isn't enough, the central bank has now admitted it managed to avoid a run on the domestic currency, the leu, sparked by several unnamed local subsidiaries of foreign banks. National Bank of Romania Governor Mugur Isarescu then took to the public stage in one of his rare shows of firmness saying those same banks later tried to recapture the money they had lost in speculative actions against the leu, this time by boosting loan interest rates for no solid economic reasons. The money market tightness seems to have eased for now, especially after the central bank stepped into the market to sell euros for lei several times, although the need for intervention in itself shows the kind of volatility in Romania's money and debt markets that will continue over the coming months.

For now, the central bank has left its benchmark rate unchanged at 10.25% and lowered the minimum reserve requirements for leu deposits in an attempt to support the currency against the effects of the global financial crisis. It's now forecasting growth of at least 4.5% in 2009 from a previous forecast of 6%. If the next government will focus on investments in infrastructure and farming, the economy could even expand by another 5-6%, Isarescu said on November 3. The annual inflation forecast for this year stands at 6.7%, above the central bank forecast of 3.5% plus or minus one percentage point, he added.

All these numbers are, of course, based on today's conditions. However, the lack of political predictability and the increasingly slim chance of a strong government to push forward sound economic policies leave the central bank once again on its own in the battle against economic slippage. As things stand now, one thing is for sure: Romanians are set for harder times in 2009 and their leaders seem either unaware of that or not unprepared to act to ease the country's situation.

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