Regulars
ECONOMICS AND BUSINESS
Tic-toc: five ticking time bombs

by Matei Paun
November 2004

No matter which party or combination of parties the voters elect in the upcoming general elections, the new government will have much on its plate. Inconsistencies in Romania’s macroeconomic policies will come to a head and will have to be addressed. It is near impossible for a country, particularly one that must still restructure large swaths of its economy, to enjoy high growth, a positive trade balance, low inflation, low interest rates and a strong currency. Perhaps more than in any other post-communist period to date, the next mandate will be an extraordinarily difficult one, requiring important doses of diplomacy, know-how and courage in order to deal with the following issues:

1) The next government will need to choose between low interest rates and high growth and inflation on one side, versus low inflation, low(er) growth and higher interest rates. It cannot have it both ways. Should it continue to believe that it can defy economic law, then sooner or later, the bubble will burst (see recent cases in Hungary and Poland).

2) Fully liberalising capital controls by April 2005 is one of Romania’s stated objectives. Unfortunately this is likely to expose Romania’s still fragile financial markets to potential disastrous external shocks. Think about it this way: if Romania offers high interest rates and a stable or appreciating currency, then that will attract potentially enormous sums of foreign liquidity. This could result in a serious boost to the local currency, forcing it to strengthen even more, creating potential problems for its exporters and fuelling imports. As soon as the attractive interest rates have been brought down by the massive inflows of capital they will just as quickly leave in search of their next victim, once again causing havoc on the way out, as they did on the way in. Maintaining some capital controls will be essential in preserving Romania’s recent macroeconomic gains.

3) Labour migration is a huge challenge, set to grow in the years to come. Right now, some two million Romanians live and work abroad, sending back to their families approximately 3 billion euros a year. In some ways, this is an important safety valve, allowing unemployed Romanians to earn more and perhaps enjoy some transfers of knowledge, as well as giving them more of an international outlook – though there are clear limits to civic mindedness that will result from picking strawberries on a farm in Catalonia. More worryingly, Romania is using its foreign remittance payments to mask its economic policy failures. Romania must streamline its economy, attract foreign investments, encourage entrepreneurship and, in general, raise the average Romanian’s productivity – none of which seems to be happening with any great haste. People are leaving because of lack of opportunities – the government should not be let off the hook. The hope is that these Romanians will return home and propel their country forward. The risk is that, instead, they will prop up an inefficient and dysfunctional state. Future Romanian governments may have to answer the same question once posed to India’s former prime minister, Indira Gandhi: how is it that Indians succeed everywhere but in their home country?

4) Navigating the EU/US strategic alliances will grow more complicated. Already with the advent of the Iraq war, Romania got a bad taste of how complicated trying to please two masters can be. While on the one hand Romania becomes ever more European as it integrates into EU structures, it is also rising in military and strategic importance to the US, which is planning on establishing forward military bases in Romania. The most likely result will be increased tensions, particularly on the public procurement front, with Bechtel, EADS, BAE and Vinci thus far representing only the beginning of what will likely be a long list of such scandals. Let’s bear in mind that the largest public procurement contract in Romania’s history will most likely be decided by the next government: the acquisition of fighter jets. Reconciling the interests of the US, the EU and the Romanian taxpayer will not be an easy feat. Also, let’s not forget a resurgent Russia, which after all controls a large part of Romania’s energy supplies and whose influence can still affect several potential problem areas (Transnistria, and the Bistroe/Danube Delta canal are two examples). Successfully navigating these treacherous waters will require all the diplomacy Romania can muster.

5) Romania will have to fix its pension system. As it stands now, the system is bankrupt and needs to be completely redesigned. Transforming its ''pay-as-you-go'' pension system to one that is investment based will require large funds, but also a carefully thought out strategy. Currently, Romania spends about eight per cent of its budget on pensions, compared to about 16 per cent in Italy. Clearly Romania will have to spend more on its pensioners (but not in the manner in which Romania’s parliamentarians voted themselves yet another pension rise, as happened recently.)

These five problems would not exist had they been confronted earlier in Romania’s post-communist era. But prolonged indifference and negligence on the part of successive governments has allowed them to balloon into the major headaches they are today. It remains to be seen whether the next government – whichever parties form it – continue in the same vein or implement some meaningful, sorely needed reforms that squarely address them.

Matei Paun is an investment banker who has covered Romania since 1997.