The Romanian government rejects the IMF’s demands, raising fears the move may affect the country’s EU bid. by Razvan Amariei 7 November 2005
BUCHAREST, Romania | In an unprecedented move, the Romanian government last week rebuffed demands by the International Monetary Fund (IMF) on taxation, public spending, and monetary policies, leading to the breakdown of a $400 million, two-year standby loan agreement signed in July 2004.
The warning lights began flashing fast on 30 October when Prime Minister Calin Popescu-Tariceanu told journalists that the IMF’s insistence on reducing the budget deficit would prevent the country from developing its infrastructure.
“Romania has shown that it has the capacity” to take economic policy into its own hands, he insisted. By that stage, the IMF and Romania had already been involved in almost two weeks of fruitless negotiations.
That prompted fears among observers that the local economy was about to enter a crisis with the IMF. The breakdown in talks became official on 31 October, when the parties refused to budge. “I will report to the IMF directors that the IMF program with Romania is now off track,” said the IMF’s chief negotiator for Romania, Emmanuel van der Mensbrugghe.
“With the current policy stance, Romania risks entering the EU with its competitiveness weakened, growing macroeconomic imbalances, deteriorating education and health services, and significant gaps in physical infrastructure,” said van der Mensbrugghe.
Romania hopes to enter the EU on 1 January 2007, though it is looking increasingly likely that a safeguard clause will be used to delay accession by one year. The IMF’s agreement is not formally required for EU membership. But the European Commissions had earlier said that “a stable macroeconomic framework is an essential indicator of a country's degree of preparedness for membership and the status of the country's agreements with the IMF may offer valuable information in this respect.”
The IMF is unhappy that the economy and productivity rates are growing more slowly than in 2004, that imports and the country’s external debt are rising, and concerned at the high rate of inflation (expected to hover around 8.5 percent at the end of 2005).
While Romanian officials admit they have missed their inflation target, they are not so worried about growth, which is expected to fall from eight percent in 2004 to five percent this year. “We have to understand that 2004 was a very good year for agriculture and in 2005 we had six waves of floods that seriously affected the whole country,” Deputy Prime Minister Marko Bela pointed out.
The growing trade deficit, which hit six billion euro in the first nine months of 2005 – double that of the same period in 2004 – is also viewed with equanimity. “A large part of the imports are based on money coming from Romanians working abroad. We estimate about 3.5 billion euro will enter Romania this wa y until the end of the year,” the governor of the National Bank of Romania (BNR), Mugur Isarescu, told reporters.
IMF experts also took exception to the government’s fiscal strategy. The introduction of a 16 percent flat tax on personal and corporate income just days after the government came to power in December 2004 “deprived the budget of one billion euro,” they said.
Prime Minister Popescu-Tariceanu explained during a TV interview that this figure had been calculated without taking into account that the introduction of the flat tax had brought out of the shadows “150,000 jobs and revenues of billions of euros that weren’t taxed at all before.”
IMF representatives also described the projected budget for 2006 as “unrealistic” and called for measures to increase revenues – proposals that were all rejected by the government. Politicians feared a VAT hike from 19 to 22 percent would damage their reputation, while an increase in the price of natural gas for Romanian households prompted public doubts about the coherence of IMF recommendations. “They want us to reduce inflation, but increasing the gas price would result in an inflation rate of more than 6.5 percent next year,” said the BNR’s Mugur Isarescu.
The salaries of public-sector employees were another area of concern to the IMF, which wanted only one pay raise. But trade unions pointed out that the average monthly salary in health, education, culture or public administration was just around 150 euro. “We don’t want the IMF to turn Romania into a new Argentina,” said Ovidiu Jurca, deputy president of the National Union Block (BNS).
THE ROAD TO DISCONTENT
But the main stumbling blocks were undoubtedly the budget deficit and the question of what to do with revenue from privatization. These two issues come together in one area: transport infrastructure.
Only half of Romania’s 80,000 kilometers of public inter-city roads are paved with asphalt, and most of those need urgent repairs. Dirt roads make up 15 percent of the network, while the remaining 35 percent are made of tarmac or cobblestones.
But the main problem lies with the highway network: Romania – a country slightly smaller than Britain – has 228 kilometers of highways, far less than other Central and Eastern European countries, a lack that might scare away foreign tourists as well as investors.
The shortage of highways is also a serious problem for Romanian drivers. The number of registered cars is increasing massively every year and, with it, traffic. This year alone, car dealers expect to sell over 250,000 new automobiles. Another 20,000 to 40,000 are bought second-hand abroad and then brought over the border.
Under pressure from the public and from business, especially tour operators, the Bucharest government decided to prioritize transport infrastructure. And the easiest way to finance its upgrading would be by increasing the budget deficit.
Emil Boc, president of the Democratic Party (PD) and one of the leaders of the ruling center-right coalition, told journalists, “When other countries in the EU have deficits above the [EU’s] ceiling of three percent of GDP, keeping Romania’s at only 0.5 percent seems inappropriate.”
But that was deemed unacceptable by the IMF.
Some independent observers agree that raising the deficit might have a negative impact. “What is important right now is not to hurry with increasing the budget deficit, because the inflation rate will automatically grow [with it],” economic analyst Ilie Serbanescu told the daily Cotidianul
There may be a better source of funding available to develop Romania’s transport infrastructure: revenues from the privatization process. When the sale of Banca Comerciala Romana (BCR), Romania’s largest bank, is completed, the state’s coffers should be fuller by 3.5 billion euro; revenues from privatization in 2006 are expected to total around five billion euro.
The IMF wanted this revenue to be used to reduce Romania’s external debt, but Bucharest seems determined to direct it to the road sector.
Prime Minister Popescu-Tariceanu said, “The funds generated by privatization will be used for infrastructure. It is more important than our external debts, which are representing only 20 percent of GDP, among the smallest in Europe and far below the 60 percent ceiling of the EU.”
He was backed by Daniel Daianu, an economics professor and former finance minister. “It is unnatural to ‘freeze’ privatization revenues when our need to develop infrastructure is so big. It’s not the IMF’s job to tell the government how to spend them,” he said.
THE EU BID AT RISK?
While there is no formal link between the IMF and EU enlargement, the fear is that the souring of relations with the IMF will also damage relations with the EU.
Romanian Finance Minister Sebastian Vladescu stressed that the government was still determined to comply with European regulations. “We will create our own macroeconomic policies and we will go to Brussels, to prove they are correct and [that] there is no risk of derailment,” he said at a press conference.
Many experts agree. Nick Eisinger, chief analyst for Romania at the Fitch ratings agency, told Mediafax, “the suspension of the agreement with the IMF creates some anxiety, but has [only] a limited impact on the accession process.”
A Romanian economic analyst, Aurelian Dochia, wa also optimistic. “There was a tacit agreement between the EU and IMF, in the sense that the EU used IMF reports to evaluate Romania’s macroeconomic policies. But I guess the agreement being off-track is not a disaster for integration,” he told the daily Gandul
But others see the issue in a different light. Joan Hoey, an analyst for the Economist Intelligence Unit (EIU), told Mediafax, “The suspension of the agreement and the comments coming from [IMF] representatives will have a negative impact on the external perception of Romania, reinforcing current doubts regarding the government’s economic strategies.”
The leader of the former ruling Social Democratic Party (PSD), Mircea Geoana, is harsher. “Suspending the agreement with the IMF is proof of irresponsibility, especially when the European Commission’s country report on Romania underlined significant risks and the fragility of the macroeconomic framework,” he said.
Those deficiencies fell into categories widely described as “yellow cards” – warnings – and “red cards,” issues of “serious concern” to the European Commission. Romania’s hope is that it will be able to hobble on and score its goal, accession on 1 January 2007. Romania’s fear is that this spat with the IMF will be another “red card” in the European Commission’s book – and that it cannot afford many more.