Monday, March 30, 2009

Romania: Reform Credit

Oxford Business Group Latest Briefing

Following a hard winter, which saw a credit squeeze, sharp falls in exports and a slowing of investment, there is a spring feeling to the Romanian economy, with the government having brokered a $27bn funding package with international lenders. 

Under agreements reached on March 25, the IMF is to provide $17.4bn, with the EU contributing $6.75bn, the
World Bank $1.34bn and other lenders, including theEuropean Bank for Reconstruction and Development, a further $1.34bn. 

According to the IMF predictions, the Romanian economy will contract by 4% this year, a turnaround from the 7.2% GDP growth in 2008, and well off the 2.5% expansion the government forecast in its draft budget, released in January. 

News that the deal has been sealed had an immediate effect, with the local currency, the leu, gaining almost 1% on the euro by March 26. Having dropped some 18% against the euro in the past six months, the leu was in need of support, according to 
President Traian Basescu, who said he expected the leu to appreciate and liquidity to flow back into the economy. 

"I believe that Romania's national currency will strengthen a bit, at least in the upcoming period," he said. "The best moment for the leu is May, when the IMF will transfer €5bn into the accounts of the central bank." 

Basescu added that when the first 
tranche of the IMF loan will be transferred to the National Bank of Romania, this would free up funds of commercial banks held by the central bank, allowing private lenders to free up more capital for credit. 

Currently, banks are required to have 40% of their
foreign currency holdings and 18% of their leu deposits held in reserve with the central bank, limiting liquidity availability in the market. 

Though the package will bring some respite to the economic climate, it also comes at a cost. In return for the IMF's assistance, the government will have to implement reforms to state spending, the financial sector and monetary policy, said the fund's mission chief in Romania, Jeffrey Franks. 

"There will be specific reforms in the fiscal area to make sure the deficit stays low over time - restructuring
wage policies, recalibrating the pension system to make it sustainable, and improving the control and monitoring of public enterprises. The government will also introduce a fiscal responsibility law that will improve the budget process, by limiting the number of budget revisions in one year," he told local media on March 25. 

According to a 
World Bank statement, key to these reforms will be improving transparency and accountability of public financial management, while also strengthening social assistance and pensions to mitigate the effects of the crisis on the vulnerable. 

While there is no question the Romanian economy is under pressure, the government's move to seek assistance was aimed more at heading off a potential crash, rather than having to revive an economy that had already hit a tough patch. 

On March 20, Moody's Investment Service said it expected the Romanian economy to contract by 2-4% this year, with the country's debt-to-GDP ratio reaching almost 30% by the end of 2010, up from 16% in 2008. However, 
Moody's stressed that Romania's debt levels would still be well below those of other EU members. This, and the impending IMF agreement, were the reasons cited by Moody's for leaving the local andforeign currency ratings of the government and the country's local and foreign currency bond ceilings unchanged. 

"Romania's status as an investment-grade country is supported by the government's moderate debt burden," the vice-president and senior analyst with Moody's sovereign risk group, Kenneth Orchard, stated. "Its gradually deepening institutional strength, derived in large part from EU accession two years ago, is also important." 

Above all, by reaching agreement with the IMF, the World Bank and the EU, the government has sought to restore confidence domestically and among foreign investors and lenders. 

And a boost to confidence will be required, with the
central bank governorMugur Isarescu, telling a press conference on March 26 that foreign direct investment (FDI) in Romania is expected to drop from the $10.8bn of 2008 to around $5.4bn-6bn this year. 

While FDI may fall by 50%, Isarescu said there were some positives on the horizon, with the 
current account deficit predicted to fall to around 8-9% of GDP from last year's 12% and the possibility of a return to moderate growth, of around 1%, in GDP for 2010, as long as the terms of the agreement with the IMF are adhered to. 

"Thanks to this agreement, Romania will stay on the safe side in terms of economic evolution this year," he said. "The 
loan agreement will give us more time to do what we need to do, that is to attract structural funds and go ahead with the reforms." 

Having been given some breathing space, the government now has to ensure it meets its part of the bargain with its creditors, enacting reforms that have often been promised but never delivered.

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