34524 6/13/2005 11:08 05BUCHAREST1349 Embassy Bucharest UNCLASSIFIED//FOR OFFICIAL USE ONLY 05BUCHAREST1205 This record is a partial extract of the original cable. The full text of the original cable is not available. UNCLAS SECTION 01 OF 02 BUCHAREST 001349
STATE FOR EUR/NCE - WSILKWORTH, EB/IFD STATE PASS USTR USTR FOR LERRION TREASURY FOR STUART USDOC FOR 4232/ITA/MAC/EUR/OEERIS/CEEB/BURGESS/KIMBALL STATE PASS USAID
E.O. 12958: N/A TAGS: ECON, ETRD, EIND, EFIN, RO, Economic Assessment SUBJECT: IMF'S VIEW OF THE ROMANIAN ECONOMY: THE GLASS IS HALF EMPTY AND LEAKING
REF: A) BUCHAREST 0189, B) BUCHAREST 1205
SENSITIVE BUT UNCLASSIFIED - NOT FOR INTERNET DISTRIBUTION
1. (SBU) According to the IMF's Resident Representative in Romania, the Romanian economy shows signs of overheating this year and Romania's economic situation weakened in 2005. Inflation and the current account deficit are two leading indicators that will likely fail to meet targets by year's end. The IMF will likely continue to press the GOR to implement unpopular tax increases, including Value Added Tax (VAT) raises. IMF pessimism extends to the GOR's proposed Property Investment Fund project, as well as to the management and organization of the GOR and Ministry of Finance. END SUMMARRY.
IMF STILL NEGATIVE ON ROMANIAN ECONOMIC PERFORMANCE
2. (SBU) Econoffs on June 9 met with IMF Resident Representative Graeme Justice for his perspective on Romania's economic prospects prior to the IMF technical assessment team's arrival June 14. He continues to be pessimistic about the overall health of the Romanian economy (see Ref. A for a report on our last meeting with him) and sees strong signs of over-heating in the Romanian economy. In particular, he points to the 12.1 percent higher household consumption posted in the first quarter. Justice also predicts annual inflation of approximately ten percent this year, compared with the GOR's seven percent target. Justice's projections are based on the relatively high inflation numbers posted in March and April, as well as the strong growth in business and consumer credit. Additionally, Justice worries about the current account deficit which he expects to reach 8 percent of GDP by year's end, compared with the official target range of 6.5 to 7.0 percent. He bases this revised projection on the current account deficit's unexpected growth in the first quarter (up 96.2% in USD compared with 1Q04). In spite of this bad news, Justice admitted that revenue numbers were strong for the first four months of 2005, up six percent from last year, although May's numbers were a little weak. These strong revenue figures give the GOR additional budget maneuvering room.
3. (SBU) Other big budget items that concern Justice include arrears owed by Romania to the health care sector, the upward adjustment in pensions, public sector wage increases promised by the former government and unexpected emergency aid costs for flood victims. Preliminary flood cost estimates approximate ROL four trillion ($135.44 million), although only one trillion has been requested to date. Medical arrears top the ROL seven trillion mark($237 million), and could increase. Possible demands for compensation for damages related to the Resita steel plant failed privatization (Noble Ventures case now in adjudication at the ICSID) would also represent another large liability for the GOR.
4. (SBU) In spite of these demands, Justice stated that the IMF and the GOR are reaching a budget rectification agreement which includes a deficit target of 0.744 percent of GDP, as well as cuts in material expenditures. Justice refers to the budget as "tight, but manageable", yet points to the demanding schedule of natural gas price hikes, which will raise prices by 30 percent next year, as potentially destabilizing if the GOR bows to social pressures.
IMF PRESSES FOR FUTURE TAX HIKES
5. (SBU) Justice believes that tax hikes are the answer to Romania's woes. The GOR will propose a new tax package next year which will seek to recover the two percent lost by this year's tax changes. Justice stated that the GOR must increase the current 19 percent VAT next year unless it wants to meddle with the heralded 16 percent flat tax, a politically unpopular move. Although he stated that VAT collection has been strong due to high consumption since January, excise tax collection was weaker due to the ROL's appreciation. He continues to lack confidence in the ability of the flat tax to generate additional revenues, and felt that the tax cut would affect the economy by June at the earliest. NOSTALGIA FOR THE PSD
6. (SBU) Justice opines that several Ministries in the current GOR show enormous capacity constraints. He also assesses many of the current Finance Ministry (MOF) officials to perform less well than their predecessors in the previous Social Democratic (PSD) government. For example, he believes that Ministry of Finance Secretary of State Doina Dascalu in charge of budget issues has little authority, compared with PSD predecessor Gheorghe Gherghina. In addition, he views MOF Secretary of State Dragos Neacsu as a "glamour seeker" who desires to tap into the capital markets for the exhilaration of money raising. In Justice's opinion, Neacsu's efforts to extend maturities on Romania's old Eurobond issues are misguided, and should be postponed. Justice further believes that Minister of Finance Ionut Popescu and Neacsu have developed an overall unhealthy obsession with the capital markets. Justice cited the great difficulty in obtaining information from the Ministry of Finance on sensitive topics including heating subsidies as proof of the government's disorganization.
A JAUNDICED VIEW OF THE PROPERTY INVESTMENT FUND
--------------------------------------------- --- 7. (SBU) The Tariceanu Government has proposed the creation of a real estate investment fund to address the property restitution issue without drawing from government funds (see Ref. B). Justice feels strongly that the proposed fund, which would compensate owners whose property was confiscated during Communism, would engender corruption. He views the fund's model as providing too many opportunities for malfeasance, as decisions such as valuations of property are subjective and may be influenced by bribery. However, Justice lauds the idea of the fund in itself, as it avoids a negative budget impact while seeking a way out of a challenging political problem. Justice remains concerned about the GOR's haste in presenting the draft to the Parliament and the intention of voting on it before recess in a few weeks.
8. (SBU) The glass is not only half empty for the IMF in Romania, but it is a bit leaky at this time. Post is not as certain as the IMF that the Romanian economy is overheating in a manner that cannot be controlled. Post will be sending a cable on this year's first quarter macroeconomic data for Romania via Septel.
9. (SBU) Post is frankly a bit concerned that Mr. Justice appears to exhibit nostalgia for the previous PSD government, which Post believes to have contained far more corrupt officials than the current GOR. His frustration with dealing with a chaotic new GOR may explain this. In Post's experience, however, several of the new MOF officials have shown themselves to be eager, innovative, pro-American and honest.
10. (SBU) Post finally notes, that although Graeme Justice began the most recent meeting by emphasizing the Romanian economy's negatives, he did not indicate that there was a "show stopper" that would prohibit the Standby Arrangement from moving forward. He also seemed heartened by the MOF's desire to come to the table and seriously negotiate a budget rectification in spite of his complaints about GOR disorganization. Justice's use of the phrase "tight, but manageable" is an indication of the direction the review may take. However, as noted, any sudden shock to the economy that places substantial demands on the GOR budget could quickly reverse this encouraging picture.