Political situation
Romania has scored major foreign policy successes in recent months. In its progress report issued on 6 October 2004, the EU Commission stated for the first time that Romania had a functioning market economy and the capacity to cope with competitive pressures and market forces within the Union. In this assessment, the Commission acknowledged Romania’s progress in carrying out reforms, yet also emphasized the need for it to continue structural reforms to strengthen the macroeconomic stability achieved thus far. The EU also sees a need for action in adopting and implementing the acquis communautaire, in moving forward with public administration reforms, and in fighting corruption. The pace of negotiations on EU accession has also picked up. After successfully completing three negotiating chapters (Agriculture,
Financial and Budgetary Provisions, Energy) in June, Romania managed to close two further chapters in September (Free Movement of Services, Regional Policy).
This means the country has thus far closed 27 of 31 chapters. The government wants to complete accession negotiations with the EU by the end of 2004, thus paving the way for EU accession by 2007.
With four chapters remaining (Competition, Justice and Home Affairs, Environment, Other), this goal remains within reach. These successes have also put additional wind in the sails of Prime Minister Nastase and his ruling Social Democratic Party (PSD) in the run-up to the parliamentary and presidential elections on 28 November. Nastase, whose candidacy for the presidency was officially announced at a special party congress of the PSD on 27 August, has good chances of being elected for the next five-year term. According to opinion polls, he is clearly in the lead, with an approval rating of just under 50 %. If he wins the election, Nastase will have to resign as head of the PSD. Incumbent President Ion Iliescu’s return to the helm of the PSD appears to be a done deal. Foreign Minister Mircea Geoana would succeed Nastase as prime minister. In terms of the relative strengths of the parties, the alliance of the ruling PSD and the Humanist Party of Romania (PUR) currently has a popularity rating of 40 % in the polls. This gives it a ten-percent edge on the opposition alliance consisting of the National Liberal
Party (NPL) and the Democratic Party (PD). The nationalistic Great Romania Party (11 %) and the Democratic Union of Hungarians in Romania (5 %) should both reach the crucial 5 % hurdle to win a seat in parliament. On 28 September, both chambers of the Romanian parliament reconfirmed Mugur Isarescu as Governor of the National Bank of Romania for the next five years. This will be Isarescu’s third term in this office, which he has held since 1990. He is seen as a guarantor of a stability-oriented monetary policy. His main goals for the coming term are to bring inflation down to between 2 % and 3 % by the end of his third term, to carry out the currency reform set for mid-2005, the full liberalization of the capital account and the full convertibility of the leu.
Economic situation
The Romanian economy grew at a rate of 6.6 % in real terms in the first half of 2004. This means the pace of growth in Romania accelerated in the second quarter of 2004 to 7.0 % year-on-year following an already robust real GDP growth of 6.1 % in the first quarter. This dynamic growth is being fuelled by strong domestic demand, particularly in private consumption, which rose by 9 % in real terms in the first half of 2004. This stimulated retail trade, which grew by an impressive 14.1 % year-on-year in the first six months. The other domestic components are also quite robust. The progress made in restructuring the corporate sector boosted gross fixed capital formation in the period under review by 10.4 % year-onyear in real terms. Public consumption also grew strongly (+6 %) in light of the upcoming parliamentary elections.
Strong domestic demand led to a boom in imports (+19.1 %), a figure which outstripped even the strong growth of exports (+17.1 %). As a result, the contribution of foreign trade to GDP was negative. Prospects for the second half of 2004 resemble those of the first, with private consumption remaining the main pillar of growth thanks to a strong increase in borrowing
and real wages, and a favorable job climate. Investment is also likely to support growth given the record FDI influx and the consequent investments in machinery and equipment. We forecast 6.3 % growth for the year as a whole.
FDI Boom
Due to the high level of domestic demand, the current account deficit continued to deteriorate in the second quarter of 2004. The deficit consequently rose in the first six months of the current year, from EUR 1.29 billion (6.4 % of GDP) in 2003 to EUR 1.62 billion (7.2 % of GDP) in 004. All sub-balances of the current account worsened against the same period the year before except current transfers. However, this widening of the current account deficit is not a cause of concern in regard to financing considerations. The net FDI inflow in the first half of 2004 limbed from EUR 785 million in 2003 to EUR 1.16 billion in 2004 and thus covers two-thirds of the deficit.
Encouraging progress in privatizing state-owned enterprises such as the oil company Petrom, the power utilities Electrica Dobrogea and Electrica Banat and the gas companies Distrigaz Sud and Distrigaz Nord bodes well for record inflows of FDI. We forecast an FDI inflow of as much as UR 3 billion for 2004 as a whole. This would offset nearly the entire current account deficit, hich is forecast to be in the order of EUR 3.3 billion, or 6 % of GDP. Moreover, foreign currency reserves were boosted from EUR 6.4 billion at the end of 2003 to a record level of EUR 9.7 billion at the end of September 2004, primarily through interventions by the NBR on the foreign exchange market. This provides a sufficient cushion if financial bottlenecks should occur.
Reduced inflationary pressures
Tax and price adjustments on cigarettes, alcohol, fuel, gas and energy pushed inflation up temporarily in July and August, as expected. This did not affect the general downward trend in inflation, however. After the effects of the first and second rounds of adjustments fizzled out, the rise in consumer prices in September slowed to a year-on-year rate of 11.1 % (September 2003: 15.9 %), bringing the average rate for the first nine months of 2004 to 12.6 % (I–IX 2003: 15.5 %). The disinflation trend in place since the beginning of 2004 has been greatly supported by the upward pressure on the leu. In light of this general trend, the NBR lowered the policy rate on 2nd November, the fifth reduction in 2004. The rate was again reduced by 50 basis points, from 18.75 % to 18.25 %. All things considered, we believe inflation could be pushed to under 10 % by the end of 2004. This would make further interest rate reductions likely in the remainder of the year. For 2004 as a whole, we forecast average annual inflation of 11.8 %.
Revision of budget
The Ministry of Finance announced a revision of its deficit target for 2004 at the end of August for the second time this year. The original figure of 3 % of GDP set for 2004 as a whole was first lowered to 2.1 % in June under an agreement with the IMF and then to 1.64 % of GDP in late August. The revision of the budget was made possible mostly by above-target revenues attributable to Romania’s current dynamic economic growth and its high level of private consumption.
The draft budget for 2005 assumes economic growth of 5.3 % and an inflation rate of 7 % at year end. The deficit target for 2005 was set at 1.5 % of GDP in spite of the planned tax reform. We consider this target to be realistic given the good prospects for growth and the related favorable development of revenues (especially VAT, excise tax and customs duties). When the election year 2004 is over, the government will also have an easier time steering a more restrictive budgetary course. The progress being made in structural reforms, especially in the privatization of ailing state-owned enterprises, will likewise ease the pressure for subsidies and allow a more disciplined approach to spending.
Outlook
There are at present no signs that the parliamentary elections will bring about a change in government. This would assure a degree of continuity in the government’s work for the first time since the collapse of the Iron Curtain. The government seems to have managed to strike a good balance between the pressures of the election year and the need for economic reform, and economic prospects are quite encouraging. The economy will outstrip the growth rates of previous years in 2004, and GDP in 2005 will even surpass the level of 1989. The downward trend in inflation will remain in place despite the need for further adjustments to prices and taxes.
The government has displayed budgetary discipline on several occasions in recent years. Backed by dynamic economic growth and an increasingly efficient tax administration, it will continue to do so in the years ahead. Standard & Poors already recognized Romania’s progress in implementing economic reforms, its good growth prospects and its approaching accession to the EU by upgrading the country’s rating from BB to BB+ in September. Further progress in structural reforms and the conclusion of the EU accession negotiations could garner Romania an “Investment Grade” status as early as the beginning of 2005.
