Clare Nuttall in Bucharest -

Romania surprised as second quarter GDP data released on August 14 saw it back in recession after an impressive economic recovery in 2013. The downturn, revealed just three months ahead of presidential elections, is attributed to lower government spending and a fall in foreign direct investment.

The economy contacted by 1.0% in the second quarter of 2014 compared to the previous quarter. Following a 0.2% decline in January-March, Romanian GDP has now dropped for two consecutive quarters. The percentage change compared to the previous quarter was the highest across the EU, with the 28-member bloc seeing expansion inch to just 0.2%. 

The decline in the first and second quarters of 2014 was surprising, as Romania was expected to continue steady growth driven by a forecast strengthening of domestic demand. While the economy was widely expected to slow compared to the rapid recovery seen in 2013, the fall into recession was unexpected. Vlad Muscalu, chief economist at ING Bank Romania, notes that “the actual data was well below any available forecast". 

Both the European Commission and the World Bank raised their forecasts for Romania’s 2014 GDP growth in the spring after the country topped the EU charts for growth late last year. Raising its 2014 forecast by 0.3 percentage points to 2.8%, the latter suggested domestic demand would push the recovery forwards.

Fading star?

Romania beat a raft of forecasts last year to record growth of 3.5%. Previously, the country was badly hit by the 2009-2010 international economic crisis and had been struggling to recover, but the comeback in the second half of last year had many appointing it a new star of CEE.

While there is some debate over the causes of the unexpected return to recession, lower public spending and slow absorption of EU funds are suspected as key contributors. Muscalu notes that spending is down on previous years. “The [finance ministry] spent 8.2% of GDP in 2Q13, and similar amounts in the previous years ... but only 7.4% of GDP in 2014.” 

At the same time, that does not appear to have had a significant impact on construction, somewhat surprisingly. The sector achieved positive growth despite the fall in state spending, as investment in residential and commercial property grew. 

FDI, however, has also slumped badly through the year thus far. Overall, it fell to just under €1.2bn in the first half - 10.3% lower than in the same period of 2013, according to the National Bank of Romania. This reveals a sharp downturn in the second quarter after a relatively strong showing in January-March. 

Amendments to the tax regime and social security contributions are believed to have contributed to that decline. Retroactive changes to incentives for renewable energy producers that came into effect at the start of the year have also unnerved investors. 

In addition, those forecasts of sprightly domestic demand look overly ambitious. Retail sales grew by less than expected in April-June, while the services sector contracted by 2.6%. Expectations of a bumper harvest are also now looking doubtful following heavy rains and flooding. 

100mph

The news of the recession hits less than three months before Romania’s presidential elections. Set for November, the vote is set to pit Prime Minister Victor Ponta against Klaus Iohannis - candidate for the two main centre-right parties. The Liberal Democratic Party (PDL) and National Liberal Party (PNL) are in the process of merging to form a united front against the ruling Party of Social Democrats (PSD). 

The disappointing economic performance was seized upon by outgoing President Traian Basescu, who is nearing the end of his second and final term. A long-standing foe of Ponta, he told an August 14 press conference that he believed the country was entering a crisis due to “faulty government”. 

The government, naturally, sought to downplay the return to recession, attempting to put the spotlight instead on figures showing that economic activity increased in 2014 compared to the first half of 2013. “Romania continues growth amid positive developments in industrial production and exports. Growth in the first half of 2014 compared to the first half of 2013 is + 2.6%,” the government statement read. 

Meanwhile on his Facebook page, Ponta also flagged up the annual, rather than quarterly, data. “It's as if I was driving 130 miles per hour and now go 100 miles per hour - but go straight ahead!” Ponta wrote. He sought to throw the blame back onto Basescu. “Without being blocked by a regime that just wants austerity policies, we can do much more! Therefore autumn elections are so important!”

The PM currently enjoys a lead in opinion polls. However, with a second round predicted, Teneo Intelligence’s Otilia Dhand points out this may not translate into victory. “Ponta’s lead is not surprising since the PSD has traditionally been the largest Romanian party and its candidates had always won the first round in previous presidential elections. But PSD has only actually won the second round twice, the last time in 2000,” Dhand writes. “While for now, Ponta remains the clear favorite, there is a risk that all other candidates might form a coalition against him in the second round and tip the scales.”