Romania became the third European Union member state to agree a bailout package with international finance institutions on March 25, but the belated acknowledgement that the country’s economy was in trouble might not be enough to stave off recession in 2009.

Three weeks in March marked a sharp change in Bucharest’s rhetoric after months of denials. It came after the economy posted a sharp drop in growth to 2.9 per cent in the fourth quarter, down from 9.1 per cent in the third quarter and 8.9 per cent over the first nine months of 2008.

It was still high enough to rank Romania in the top three fastest growing EU economies for the quarter and first for the full year, at 7.1 per cent.
But it also appeared to vindicate the analysts who had forecast a gloomy future for Romania after the reach of the US financial crisis spread to Europe in the wake of the Lehman Brothers collapse and AIG’s malaise.

Romania’s banking system has virtually no exposure to toxic assets from the US, but the reduction in the inflows of cash and tightening credit has hit the country hard. At the same time the sliding currency has made it difficult for many households to service their loans in foreign currency, which account for 60 per cent of total household lending at end-February, according to central bank data.

Long before the subprime collapse in the US triggered the current crisis, analysts and finance officials debated whether Romania’s economy was overheating.
Put simply, that occurs when consumption, and by extension gross domestic product (GDP), grow faster than the production capacity, relying on readily-available credit and causing a large trade gap. Both were recorded in Romania and as credit flows dried out, the unsustainable growth rate came crashing down.

Hard landing
The faster the growth, the harder the landing that follows and, in Romania’s case, that could mean following up on record growth with a year in which the economy will contract. Neil Shearing, an analyst at Capital Economics, the London-based macroeconomic research consultancy whose forecasts for Eastern Europe rank among the most pessimistic, told Reuters earlier in March that even an international bailout would not prevent Romania from entering a deep and protracted recession.

Officials in Bucharest predictably downplayed talk of recession. Central bank governor Mugur Isarescu, as quoted by Romanian media, told reporters the day after the bailout deal was agreed that it assumed a GDP contraction of four per cent in 2009, but said that he believed that "with the help of this programme, Romania will have positive growth".

For 2010, the agreed macroeconomic framework assumed a conservative growth forecast of up to one per cent.
News of the bailout package strengthened local currency the leu, which hit a seven-week high against the euro on March 30 after appreciating by about one per cent, bucking regional trends.

Analysts, however, were sceptical that the effect would be long-lived, drawing on the experience of Hungary, where the forint exchange rate against the euro lost about 16 per cent after the country agreed its own bailout in October 2008.

Austere terms
Romania will receive just short of 20 billion euro until 2011 under the terms of the bailout, with the International Monetary Fund (IMF) and the European Commission providing 13 billion euro and five billion, respectively. The rest will come from the World Bank and the European Bank for Reconstruction and Development. Separately, a further 1.5 billion euro has been earmarked by the European Investment Bank for loans to small and medium-sized companies.

The bulk of the money from the bailout package, 11.8 billion euro, will be paid this year, with a further 7.1 billion euro slated for 2010.
In exchange, Romania will have to keep its budget deficit at 4.6 per cent of GDP and cut government spending by 1.1 per cent.

The terms have been described as lenient by most analysts, since the deficit is comparable to the 5.2 per cent shortfall the budget ran in 2008. Romania’s centre-left cabinet, which scrapped the budget adopted by the previous centre-right government, will have to re-draft its own proposal, which originally targeted a two per cent deficit and 2.5 per cent economic growth.

The first target of the cuts will be public administration, Romanian president Traian Basescu said on March 31. The IMF suggested laying off five per cent of the administration and cutting the payroll of civil servants from seven per cent of GDP to five per cent over four years. The government also planned to eliminate all unnecessary spending, including bonuses to high-earning officials, prime minister Emil Boc told broadcaster Realitatea TV on March 26.

Cautious welcome
Analysts have welcomed the bailout package, saying Romania’s recession would have been worse without it, but warned that it would not solve the structural problems within the economy, only give the government the breathing space it needed to push through reforms.

"The deal with the IMF will not help with foreign demand and I doubt it would spur domestic demand, although the bailout would stabilise it in the good case scenario," analyst Matei Paun told NewsIn news agency.
Paun said he did not expect foreign investors to be moved by the news, but Nicolaie Alexandru Chidesciuc at ING Bank in Bucharest said the safety net that it provided was welcome.

"Any deal with the IMF will have a positive impact on investors. Their confidence should increase after this package is approved," he told NewsIn.

For others, the austere terms of the bailout meant that in the short run the situation might get worse before it improves. Merrill Lynch revised its GDP forecast for 2009 to say it expected the economy to contract by 3.4 per cent this year, compared to an earlier estimate of 1.5 per cent, news agency Mediafax reported. In 2010, however, the investment bank expects the economy to shrink by 3.2 per cent, an improvement over its earlier forecast of five per cent.

The key is how the money will be spent, Raiffeisen Bank Romania chief economist Ionut Dumitru told NewsIn. "The larger budget deficit should be used on investment, not current spending," he said.