Thursday, March 19, 2009

Our Hero, the bycicle repairman?

The Romanian premier proudly announced yesterday that during the negotiations with the IMF the government was capable to defend both the flat tax system and its level, because, as he put it: the loan has a preventiv character and therefore the Fund set no conditions for it. (???) The latter statement is a bit confusing as according to the prime minister 2/3 of the loan will raise the reserves of the national bank while 1/3 will be used for recapitalizing banks and restart the flow of credit in the economy. This seems very similar to the case of Hungary where a part of the loan was directed to the reserves of the cantral bank (optically it raised the rate of debt/GDP ratio although at the end it is not the necessary outcome, if it will be used for replacing outgoing debt or not used up just returned to the IMF, but market "analysts" are hardly aware of this fact, only some real economists were capable to do this simple accounting task) and the IMF set conditions for the Hungarian government as well, although not specific, rather general ones. MMoreover, the IMF seems to be very "flexible" these days regarding the individual measures, for example in the Baltics they presented their proposals for Latvia, but yielded to the Latvians pressure and accepted that the country is not ready to give up the currency peg. I suppose this was the case here as well, the IMF delegation presented an overview of the situation prepared by their staff (according to the Cotidianul the IMF forecasted 4% contraction and 4,7% budget deficit) and suggested some measures. The Romanian governemnt defended the pride of the Romanian economy, the flat tax system and the low tax rates - at least in public - vehemently and prevailed.

It is quite probable that the IMF was not sticking to their own ideas as they accepted proposals of governments in other countries as well and even they are forced to accept the rapidly changing realities in ECE, making the reaching of the goals of the IMF sometimes illusory. Romania simply repeated the tactics of some Baltic states, its politicians fought for something easy to achieve to make the bitter pill a bit sweeter, and preserve national pride. We don't know of course how proud ordinary Romanians are of their tax system, but politicians are clearly obbsessed with the idea that: a, they are, b, this tax system is the primary source of the growth of the recent years.

Maybe they are right, although I would be a bit suspicious. But the real question is what kind of measures were offered and accepted by the Romanian government to comply with the conditions of the IMF, if they are not ready to raise budget revenues even if the income of the state houshold is collapsing in the recent months? (The chairman of the social democrats, the coalitional partner of Emil Boc's PDL attacked yesterday the IMF agreement and offered instead a relaxation of the budget deficit from 2% of the GDP, implicitly suggesting that the governemnt accepted keeping this rate as a goal of the agreement, leaving not much room for easing. But once again a caveat is in order. As Boc can present a success to the public it is possible that Geoana simply wants to have his own one and fights for a larger budget deficit after it was already agreed by the IMF.) The logical solution is budget cuts, but it is a problematic issue, as we could have seen in the case of Latvia as well. Unions are preparing for demonstrations even because of the cuts in the present budget that became obsolete in one month (it was accepted in February) and with further painful measures they will be even more eager to act. The coalition is not united regarding the necessity of the loan and it is another political risk. As for the economic problems, in Romania the export oriented sectors has much lower share in the GDP than in Hungary, Slovakia or in the Czech Republic and the country's growth was driven by a real estate bubble based on credit fuelled by transfers from abroad. (According to different estimates 1,5 -4 million Romanians are working abroad, mainly in country seriously affected by the crisis, like Spain, Italy.) It was similar to the Baltic case and signs of overheating were clear, therefore the task would be not only to manage the crisis but to direct the economy on another track. The government at the moment tries to launch great construction projects based on the better absorbtion of EU funds (the plans are 10bn euros for this year!) and to relaunch stalled housing projects. The proposal is simple, but doubious: local self-governments will buy those stalled projects and finish them.

It is not sure that another path, the raising of revenues would be succesfull as well. It clearly won't be benefitial for demand, although it hardly would be the main reason for the real estate market to be frozen. As the workers abroad will be affected by the crisis it will dissipate the basis of credits and consumption and it is hard to imagine the government pump enough money to the economy to substitute 7-9bn euros a year. But the real danger could be the financing of the deficit. Romanias credit ratings are in the "speculative range" and the main reason the country was not affected by this fact earlier was the massive transfer of income from abroad and the optimism about the countries future. But it is hardly a way to follow in the coming years and the government in an effort to defend higher income form higher taxation can deprive itself from budget revenues even after the crisis is over.

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