Delicate balancing act

The Romanian government is looking to inflict short-term pain to ensure long-term improvement for the country’s ailing economy, though for some the cure is as bad as the illness, with increases in taxes and levies not being offset by measures to protect incomes and services.

Having agreed to implement a strict austerity package to qualify for the $26bn bailout floated by the IMF and the EU agreed to last year, the government is finding itself increasingly unpopular with voters, and to a degree even with the international lender, for failing to put in place some of the measures promised in its standby deal.

Among the steps taken by the government to increase revenue and reduce spending were raising the value-added tax (VAT) rate from 19% to 24% as of July 1, cutting state salaries by up to a quarter and imposing additional taxes on income from deposits. The government of Prime Minister Emil Boc was forced to adopt these unpopular measures after the Constitutional Court ruled that a proposed 15% cut to state pensions, one of the requirements of the IMF, was unconstitutional and could not be enacted.

It does appear that the government is making some headway, with the budget deficit for the first six months of the year coming in under the limit set by the IMF. As of the end of June, the budget was $5.57bn in the red, representing 3.35% of GDP, according to figures issued by the Ministry of Finance on July 28.

Though the deficit was below the IMF-mandated $5.6bn maximum, the government may struggle to maintain this performance, as the ministry’s data also showed state revenue dropping, posting a 0.1% decline for the first half of the year. Should the economy continue to retreat, tax earnings may fall further, despite the new revenue-raising measures put in place.

The problem the government faces is that while it needs to impose the austerity measures required by the IMF to qualify for the emergency funding, those same measures are applying a brake to the already contracting economy.

In late July, the European Bank for Reconstruction and Development (EBRD) warned that the government’s policies will serve to further dampen domestic demand in the short term, cooling the economy still more.

The minister of finance, Sebastian Vladescu, has acknowledged the validity of the EBRD’s concerns, saying that the new VAT rate will have an impact on growth. “We have to analyse the effect of introducing a 24% VAT to see if the recession will be of -1%, -1.5% or -2% this year,” Vladescu told local media on July 26.

Combined with the fears of a renewed slowdown are concerns that the VAT rate hike may fuel inflation, with consumer price rises currently running at more than 4% year-on-year.

The government’s commitment to the IMF-backed austerity programme has another cost as well, with the popularity of both the president and the coalition falling. The approval ratings for both President Traian Basescu and the prime minister have fallen to below 20%, according to the results of an opinion poll conducted in mid-July and released at the end of that month.

The poll also showed that support for Boc’s Democratic Liberal Party had plunged, with the party slipping to third in the rankings. Just 13.7% of those surveyed said they would vote for the main government party, down from the 33% it garnered at the November 2008 general election.

Even nature seems to be conspiring against the government, with recent flooding, coming hard on the heels of a prolonged drought, slashing estimates for the wheat crop. On July 28, officials at the Ministry of Agriculture announced that this year’s harvest was now projected to be around 6m tonnes, well down on the 6.7m tonnes forecast in June. Up to 20% of the 2m ha planted for wheat had been affected by adverse weather conditions, officials said, warning that there could be an increase in the price of bread in the autumn.

Unlike the EBRD, which has projected that Romania’s economy will contract by 3% this year, and not register any growth in 2011, the IMF has forecast that while GDP will fall by 0.5% in 2010, there will be a modest rebound next year.

Despite the IMF’s guarded optimism, it may be late in 2011 or even beyond before Romania’s economy can return to solid growth, with little to suggest that there will be too many silver linings for the public or the government in the coming months.