Phil Cain in Graz, Austria -

Bucharest markets were buoyed this week by the first upgrade to Romania's credit rating for almost three years. Economists too are upbeat, though wary of the economy's underlying problems and the temptation that cheaper credit could offer politicians in the run-up to elections next year.

On July 4, Fitch Ratings raised its assessment of Romania's credit worthiness to 'BBB-', the lowest investment grade rating, from 'BB+', the junk rating that the rating agency, together with another agency Standard & Poor's, dropped the country into at the height of a political crisis which put its International Monetary Fund (IMF) bailout deal temporarily on hold in late 2009. The yield on Romanian sovereign bonds is now the highest for any country with the same Fitch rating. Moody's Investors Service, another rating agency, rates Romania's debt as 'Baa3', a similar rating to Fitch's now.

The Bucharest's BET stock index welcomed the news, rising 2% from the previous close of 5,491 to 5,605 at the end of trading on Wednesday. The leu, meanwhile, strengthened against the euro, trading at RON4.20896 to the euro midweek, compared with RON4.23950 immediately before Fitch announced its new rating.

The upgrade comes as a two-year recession apparently nears its end, export performance improves and the current account deficit narrows. GDP rose by 1.7% on year in the first quarter, boosted by 10% growth in the industrial sector where car manufacturing performed strongly. The current account deficit is now under 4%, having stood at over 14% before the economic crisis struck in 2008.

Muted applause

Fitch's rating upgrade was given polite applause by economists. "Of course, this is good news," says Liviu Voinea of the Group of Applied Economics. "The previous grade was unfair."

However, he warns there are potential downsides to achieving a better reputation in the markets. "It will impact the exchange rate and potentially attract speculative investors, or hot money."

The government will also have to be more strong-willed to resist the temptation to borrow excessively, "Now that Romania can probably borrow cheaper - a likely result of the upgrade - we must be careful not to borrow too much," Voinea says.

Romania's economy ran into trouble at the same time as the global economic crisis hit, but was already in bad shape and is far from a picture of health now.

Ongoing problems include sluggish growth, the highest inflation rate in the EU and an ongoing fall in households' purchasing power. The official unemployment rate of just over 7% hides the fact that 2m Romanians, or around 10% of the population, work abroad. At 8.5%, inflation is the highest in the EU and still rising, with poorer households feeling the pinch most from a spike in food prices.

Fitch's improved assessment was also cautiously welcomed by other economists. "The upgrade was a pleasant surprise," says Dan Bucsa, chief economist at UniCredit Group, an Ital-based bank in the region. "Romanian banks were expecting a return to investment grade in 2012, after two rounds of elections, local and national, which would probably have tested the deficit reduction."

The upgrade does not mean the Romanian economy is out of the woods, however. "Contagion worries from the EU periphery's debt troubles are likely to persist until a stable solution is found to current solvency problems," Bucsa says, though adds that Romania is not as exposed to Greek contagion as some might think, with exports to Greece making up just 1.5% of total exports.

There is more reassurance to be had. The banking system in Romania is, Bucsa says, well capitalised, with an average solvency ratio of 14.75% and 15.7% in the case of Greek subsidiaries operating in Romania. The central bank's foreign exchange reserves cover the amounts lent by Greek banks to their Romanian subsidiaries by a factor of more than eight, he says.

Romania has received two IMF bailout programmes, one ending early this year and another end in 2013. So far, these have "proven to be good anchors for improving public policies and cutting the budget deficit," according to Bucsa, who says 2011 deficit target of 4.4% of GDP is "well within reach."

Voinea says, however, the 25% public sector wages cuts and 15% cut in the state pension that delivered the improved ratios needed to satisfy the IMF do not constitute structural change and slowed the recovery.

Public debt is unlikely to exceed 40% of GDP in the medium term, according to Bucsa, "if no major spending slippages occur." But only time will tell whether politicians can resist the powerful incentive to indulge in a spending spree to secure the votes of a population weary of austerity.