Andrew MacDowall in Belgrade -

Anti-government street protests in Romania are now into their third week, despite a climb-down from the authorities and worsening weather. And while the demonstrators' grievances are familiar by now - swingeing public sector cuts, low salaries, tax increases, corruption, and the perception that President Traian Basescu and his administration are remote and authoritarian - potential solutions are considerably less clear.

Gone are the days when the country was an emerging market darling, a sort of Eastern European tiger leaving "Old Europe" in its wake. The crisis has exposed the Romanian economy for what it is: comparatively poor, misgoverned and hemmed in by the uncertain global situation.

The ongoing protests were triggered by the resignation of the popular deputy health minister, Raed Arafat, who had clashed with Basescu and the president's close ally Prime Minister Emil Boc over a new health law. Arafat was the head of Romania's medical emergency service, widely seen as one of the few public services to function cleanly, efficiently and effectively, and thus the ethnic Palestinian doctor was something of a light in the darkness.

Arafat's swift reinstatement and the scrapping of the health law in the face of demonstrations mollified some protesters, but not all, and a hard core of several hundred have continued to gather in central Bucharest. They say they will not move until Basescu and Boc stand down.

The down years

While not particularly numerous, and despite allegations that they are infiltrated by groups ranging from football hooligans to rogue elements in the security services, the demonstrators are widely seen as expressing the disillusionment and anger of much of the population.

After several years of rapid expansion between 2001 and 2008 - during which GDP growth rarely dipped below an annual 5%, and at times surged towards 10% - the economy hit the buffers in a big way. Foreign direct investment, a leading growth driver in the good years, plunged as foreign-owned banks looked to shore up at home, and investors became increasingly aware of the risks inherent in Romania's unbalanced economy.

In spring 2009, facing a debt crisis, Romania took a €20bn emergency loan from the International Monetary Fund (IMF), on the condition that serious fiscal tightening was implemented. Thus in 2010, the government cut public sector wages by 25%, and raised VAT by five points to 24% - austerity measures that are one of the root causes of the current protests.

Romania's economy shrank by more than 7% in 2009, and contracted a further 1% in 2010. The government thus found itself undertaking cuts and tax rises during the country's worst economic crisis since the early 1990s. While the tough measures have the support of the IMF and, for the time being, the markets, they are also undermining Romania's recovery. The economy grew by just 1.5% last year, and 2-3% seems likely for 2012 - lower if the Eurozone crisis worsens, as is entirely possible.

It is unlikely that angry Romanians will be appeased by being reminded that it is not so long ago that incomes were rising rapidly, supported by active government policy. Net wage growth averaged 20% in 2007, according to official statistics. The same year, the government hiked average statutory public sector wages by between 9% and 15%, raised bonuses and increased the state payroll. The following year saw substantial increases in the minimum wage. Theoretically, these were admirable efforts to share the nation's increasing wealth. But in practice they were also electoral gambits - and they stoked inflation and widened the fiscal deficit, as the IMF and others warned at the time.

Romania thus has been caught in a pro-cyclical trap - demand-stimulating and inflationary spending and wage increases during good years, and then being forced to tighten just when fiscal loosening could support growth.

While the 2008 election saw Boc and his coalition elected, and incumbent Calin Popescu-Tariceanu defeated, the change was not as significant as the result might suggest. Basescu remained president and played a forcefully active role in domestic policy, while many of the parliamentarians in Boc's coalition had previously been in Tariceanu's. Today's government must shoulder much of the blame for the policies of the boom years, and now faces the consequences.

The parliamentary opposition - the socialist-led USL - has been supportive of the protestors, but only cautiously so, as its members are well aware that the demonstrations are an indictment of the entire political class. Nonetheless, it will be optimistic about the chances of victory in this year's local and parliamentary elections (there is an ongoing political wrangle about whether these will be held concurrently, as the government wishes). The USL's pitch is "to focus on promoting economic growth instead of austerity," the economist Liviu Voinea tells bne.

Promises include reversing some of Boc's measures and bringing in technocrats to top positions (something Romania has experimented with in the past, with reasonable results), but radical change as demanded by the protesters seems unlikely. The USL is a somewhat unwieldy coalition, and carries the burden of previous socialist administrations' failures. It may also have to deal with some months of cohabitation with the wilful Basescu.

Poisoned chalice

The new government, whatever form it takes, faces an unenviable situation: a restive public and the need to reinvigorate the economy without imperiling fiscal stability. Romania remains the second-poorest EU member after neighbour Bulgaria, a gap which won't close for decades - the average gross salary is below €500, according to official figures. While declared unemployment is not that high, actual employment rates are low, at under 60%.

The public administration is desperately in need of reform: unwieldy, ridden with corruption and inefficient - one of the reasons behind Romania's sluggishness. "There is still a mix of waste in public spending on inefficient investments and acquisitions, and sub-optimal allocation of resources for education or health," Voinea says. "While the opposition is not innocent, the current level of misuse of public funds is unprecedented. Public investments and acquisitions must be subject to independent audit and prioritised based on the rate of return."

Indicative of the malaise is that, after five full years of EU membership, absorption of EU funding is still abysmally low at around 5%. As well as structural reform, Voinea calls for the reinstatement of progressive taxation and higher property taxes to address the deficit - though these would probably be unwelcome among the business community.

It is a wish list much more easily said than done. But there are certainly blessings to be counted - Romania is a large and significant market that foreign investors won't shun forever. The austerity programme, however harsh, has calmed the markets, allowing Romania to borrow at favourable rates, as a successful bond sale in this month indicates. Overall public indebtedness is remarkably low, at around 35% of GDP. The central bank is well regarded. There is promise in a number of sectors, from mining through logistics to tourism. "Romania has a lot of potential," a prominent Bucharest lawyer told your correspondent in 2006. "It probably always will have."

It's a gloomy prophecy, and one that the next government - and its successors - will have their hands full in making sure it isn't realised.