Romania's budget needs revising as IMF aid looms

By bne IntelliNews March 4, 2009

Graham Stack in Kyiv -

Hardly a week has passed since Romanian President Traian Basescu signed into law the budget for 2009. But with news emerging March 2 that the government has started preliminary talks with the International Monetary Fund on an aid deal to help patch up the country's strained finances, the budget is already in urgent need of revision.

Passing the 2009 budget was difficult enough. A hard-fought, high-spending election year in 2008 - which saw salaries for teachers hiked by 50% in November, weeks before parliamentary elections - left Romania ill prepared for the belt-tightening needed in the wake of the financial crisis that impacted in the last quarter of 2008.

However, a new broom belonging to Prime Minister Emil Boc, only sworn in on December 15, pushed through a crisis budget that bravely slashed the budget deficit to 2% from 5% in 2008, and froze public sector wage growth. This, despite the fact his government depends on a coalition between his own Democratic Liberal Party (PD-L) and their traditional bitter rivals, the leftist Social Democratic Party (PSD).

But less than a week after President Basescu signed the budget into law, a growing chorus is saying that the underlying growth forecast of 2.5%, and consequently the planned budget deficit of 2%, is wildly unrealistic. "The target for the budget deficit becomes unrealistic under our assumptions of a 3.5% GDP contraction in 2009, as this will have a very strong impact on revenues. Our forecast is for a 7.3% GDP deficit," Nicolaie Alexandru-Chidesciuc, senior economist at ING Bank Romania, tells bne. "Any target below 5% of GDP would require additional cuts in spending and/or hikes in taxes."

The rating agency Standard and Poor's, which in October sensationally downgraded Romanian debt to junk status, also predicted on March 2 that the budget deficit would reach 5.0-6.2%. Such gloomy prognoses are backed by January's economic data, which showed several main budget revenue items falling 8% in January on the year in nominal terms as the global crisis took its toll on the domestic economy. The budget that President Basescu signed into law on February 25 envisages 18% growth in revenue in 2009.

Romania's budget problems are, however, not only the result of the global economic crisis, but are also homemade. Recent years' stellar economic growth went hand in hand with weakening budget discipline, which is now coming home to roost. "Government spending doubled between 2005 and 2008, and the public sector wage bill nearly tripled over these three years due to high wage increases combined with a large increase in government employment," an IMF mission to Romania said in a statement on February 4, a point tacitly admitted by the prime minister.

"It's a shame that we failed to capitalise on economic growth, to set aside some money for a more difficult year," PM Boc lamented in February.

IMF medicine political poison for coalition

With financial markets effectively closed, yawning capital account and budget deficits together with a banking system threatened by foreign-denominated loans and a depreciating leu mean that Romania has now been forced to look for emergency funding sources.

First up is the EU with which Romania is conducting official negotiations for financial support. But Romanian officials confirmed to newswires March 2 that a team led by the central bank's deputy-governor, Cristian Popa, had been dispatched to Washington for preliminary talks with the IMF.

The IMF already stated February 4 that it would require Romania's budget deficit to be further reduced before disbursing any loans. But Romania, like troubled neighbour Ukraine, is now embroiled in the run-up to presidential elections in late 2009, meaning it is a bad time for swingeing budget cuts. PM Boc is a party colleague of President Basescu, who is up for re-election in December.

At the same time, the PD-L's coalition partner is its traditional foe, the leftist PDS, which took the largest share of the vote in November's elections. The PDS, with ties to organized labour, will be even more allergic to cuts in state spending. "Given Romania's history of poor industrial relations, the government may struggle to impose budget cuts in practice, which suggests a somewhat strained outlook for relations with the IMF," reckons Royal Bank of Scotland's head CEE analyst Timothy Ash.

Boc is still fighting shy of the IMF, arguing that 20% of budget expenditure slated for 2009 is infrastructural investment that will stimulate the economy. He insisted March 2 that the only official talks Romania is engaged in are with the EU. But many analysts see an IMF agreement as inevitable for Romania, given the capital account and budget deficits that resemble those of the new IMF-debtor nations Latvia, Ukraine and Hungary.

ING's Alexandru-Chidesciuc suggests a compromise could eventually be found, with some required spending cuts deferred to 2010. "I think the IMF would accept a budget deficit probably even slightly higher than 3% of GDP this year," he says. "It will concentrate on a programme aiming gradual and sustainable correction of the budget deficit. This would imply a much lower budget deficit in 2010, but I don't believe the IMF will ask for a budget surplus even in 2010."

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