London analyst: "The medium-term outlook for the Romanian economy is negative"

In an exclusive interview for Hotnews.ro, London analyst Alice Mummery, working with Business Monitor International, has pessimistic prognosis about the future of the Romanian economy and estimates that the future government will be forced to adopt unpopular measures.

HotNews.ro: The State Budget law approved yesterday by the Romanian Government is almost identical with the one for 2008, estimating a 6% growth in 2009, an inflation rate of 4.5% and the exchange rate for euro at 3,6 lei. Do you think that such a budget is sustainable in the conditions of the international financial crisis? What should we expect in 2009 in Romania, which crisis effects will be felt here?

Alice Mummery: We believe the medium-term outlook for the Romanian economy is negative. The continued slowdown of economic growth in the eurozone in 2009 will significantly weigh on demand for Romanian exports. In addition, the tightening of global credit means that we are likely to see a sizeable reduction of capital inflows into Romania which will lead to a substantial slowdown in both investment and loans. Thus, Romania is likely to find it increasingly difficult to finance its current account deficit – which significantly adds to the risk of a depreciation of RON/EUR.

Going forward, given the increasing risk to the Romanian economy, we believe that the Romanian government’s projections for 2009 are over optimistic. Indeed, Business Monitor International forecasts growth to slow to 3.1%, inflation is expected to slow to 3.1% y-o-y in December next year as domestic demand essentially collapses. In addition, we expect downside pressures on the lei to remain and forecast an exchange rate on RON3.9000/EUR for the unit.

HotNews.ro: Which should be the taxation policy of the Romanian Government for 2009?

Alice Mummery: While we do not provide opinion’s on individual states taxation policy, it is clear that a trying period lies ahead for the Romanian government. Clearly the government will be forced to make tough choices between raising revenues through tax increases, or slashing expenditure – neither of which will be politically popular.

HotNews.ro: Which are the risks regarding the budget and the fiscal policy for the next year? Was it reckless to draw a budget for 2009 similar to this year, knowing that the crisis already has effects on Romania as well? If Romanian government will be forced to raise the salaries of the budgetary sector, the budget deficit could raise at 6%, how could Romania finance such a deficit?

Alice Mummery: The core risk to Romania’s fiscal policy next year will be financing the populist measures (such as pensions hikes) approved in the run-up to the November 30 election. This combined with the tendency for a pro-cyclical fiscal policy will substantially elevate the risks faced by Romania at the end of 2008 and into 2009. We currently forecast a budget deficit of 2.7% of GDP in 2008, rising to 2.9% in 2009 – although stress that the risks to our projections are elevated. Nevertheless, should Romania exceed the Maastricht criteria, which states that the budget deficit must not exceed 3.0% of GDP, we would expect investor confidence in the country to be damaged further.

We caution that Romania is likely to find it exceptionally difficult to fund its expansionary fiscal policy in 2009, due to tighter global credit conditions. The government’s proposals will not be sustainable due to the bleak external outlook and increasing risks to macroeconomic stability. Going forward, the National Bank of Romania will need to continue maintaining a watchful eye over Romanian monetary policy – in a bid to reduce the risks faced by Romania.

Ultimately, we anticipate that the Romanian government will be unable to find the funding to finance massive public sector wage increases. Indeed, tax hikes to finance public sector wage increase would likely be deeply unpopular, while securing the funding from abroad to finance fiscal spending is an option which we do not expect to bear much fruit. However, we caution that expansionary spending at a time when investor risk aversion is already heightened will do little to shore up the downslide in investor confidence.

HotNews.ro: Regarding the downgrading of the country rating by S&P, it will be more difficult and more expensive to get an external credit. Will Romania have to find internal sources to finance its budget deficit?

Alice Mummery: The tightening of global credit lines combined with the downgrade in Romania’s foreign currency credit rating ‘BB+’ will undoubtedly make it more difficult and expensive to get external credit. Given that we expect economic growth to slow significantly in 2009, Romania will also find it very difficult to fund the budget deficit from internal sources.

HotNews.ro: Which can be these internal sources? Is the raising of the taxes a solution? Can Romania tax payers, companies and persons, afford new taxes? Which will be the best evolution of the fiscal policy? Which taxes could be raised: the direct or the indirect ones?

Alice Mummery: In general, it does not seem particularly prudent to raise taxes in a period of slowing economic growth, as this runs the risk of extending the period of economic downturn. The preferred action from a macroeconomic standpoint would be to cut non-productivity orientated spending.

HotNews.ro: IMF representative in Romania, Juan Fernandez-Ansola, said that Romania should show the foreign markets that it has the fiscal policy adapted to the current situation. Which could be such signals, how can encourage investors to still come to Romania?

Alice Mummery: By reducing the country’s budget deficit target for 2009, and adopting a much more prudent fiscal policy, Romania would signal to the International Monetary Fund and foreign investors that the country was adjusting to the downturn in the external environment. We believe that in this period of flight to safer assets, country’s across the emerging Europe region will find it difficult to attract foreign investment. However, if the risk to Romania’s macroeconomic stability begin to subside, investors will become more confident about investing in Romania.

HotNews.ro: Which are the main risks regarding the fiscal policy of Romania now, when we are having elections and maybe we will have a change of political colour in the government and the parliament?

Alice Mummery: The main risk to Romanian fiscal policy in the short-term is the substantial uptick in populist measures ahead of the November 30 parliamentary election, combined with the tendency to backload fiscal spending in the final quarter of the year – which elevates the risk of the budget deficit ballooning beyond manageable levels.

In addition, a further factor which is likely to lead to amendments of the country’s fiscal policy is a change of government following the election. Indeed, public opinion surveys by INSOMAR and CURS see the National Liberal Party (PNL) trailing behind the Democratic Liberal Party (PD-L) and the Social Democrats (PSD). Should we see a PSD-led government, we would expect the pursuit of an expansionary fiscal policy to continue. However, the PD-L appear to offer a more realistic approach in the present economic climate, favouring a more restrained fiscal policy.