Markets see no quick fix for Romania policy blunders

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Marius Zaharia
No matter who wins Romania's general election this month, none of the main contenders is committed to the cuts in spending needed to reduce the risk of a currency crisis, spelling more trouble ahead for local markets.
Analysts say a vast current account gap makes the new European Union member one of the most vulnerable countries in the bloc to a global crisis that has already triggered financing problems in neighbouring Hungary and Baltic state Latvia.
With the external deficit around 14 percent of gross domestic product, unlike western Europe and many of its eastern peers, Romania's main challenge is to tighten budget spending rather than stimulate its already fast-growing economy.
But all the main parties in the Nov. 30 vote are outbidding each other with spending plans and none have made a clear commitment to fiscal austerity that would help rebalance the economy.
'There is a high probability a currency crisis can develop, should the government fail to rein in spending,' said Elisabeth Gruie of BNP Paribas in London.
'It does not take long for speculators to attack a currency when fundamentals are poor enough, see Iceland.'
Local markets have fallen along with the rest of central and eastern Europe in recent months, with the leu hitting four-year lows near 4 per euro in October and stocks losing two-thirds of their value in 2008.
But five-year credit default swaps (CDSs), a key indicator of risk levels, have risen more dramatically than in neighbouring countries, widening by over 100 basis points in a month to more than 600.
Compared with around 200 in Poland and below 500 in Hungary, they underline concerns about Romania's future outlook, unclear prospects for a new government after the election and its policy response to the financial crisis.
Such worries have led Standard & Poor's and Fitch Ratings to cut Romania's rating to below-investment grade in recent weeks, making it the only EU member with 'junk' status.
The currency is likely to bear the brunt of any investor concern over poor economic policy-making, largely because Romania's debt market is virtually illiquid and there are barely any foreign players left on the bruised stock exchange.
For now, the leu is expected to trade in a wide range around this month's level of 3.7-3.8 per euro in coming months. But BNP Paribas' Gruie says it may hit a new four-year low around 4.2 per euro next year, if the global mood deteriorates.
'The adjustment of internal demand cannot be delayed,' central bank governor Mugur Isarescu warned recently.
'We could have a smooth adjustment or an adjustment from external capital markets which will be neither smooth, nor will it have reasonable proportions,' he said.
One factor that gives leu investors some consolation is expectations the central bank, struggling to curb inflation, may step in to the market to protect the currency if it weakened sharply.
It did so in October when global financial woes spiralled out of control, punishing emerging market currencies.
Unlike Iceland, which collapsed under the weight of its debt last month, Romania has vast hard currency reserves worth 27 billion euros which it can use to fight any sell-off.
Romania feels the need to defend the leu from a stiff fall because much of its private debt is euro-denominated, but the central bank will also be intervening to support the currency at a time when it needs to lower interest rates to support growth.
Economists expect growth rates to at least halve next year from a forecast 9-percent expansion in 2008. Interest rates are among the highest in Europe at 10.25 percent as the bank bids to quell inflation still running at 7.4 percent.
Romania's biggest chance to cool some of the pessimism and maybe bring some investment back would be to overcome strong party rivalries quickly and form a government with a credible plan for fiscal tightening by the end of the year.
'But of course, that's not the outlook in Romania,' said Lars Christensen, an analyst at Danske bank.
Instead, public opinion surveys suggest the two main contenders, Democrat-Liberal Party (PD-L) and the Social Democrat Party (PSD), are locked in a close race and will have to negotiate aggressively to form a coalition.
Any government including the PSD may be the least likely to tighten fiscal belts -- and reassure jittery markets -- because of its history of botched reforms in previous governments.
'If the PSD come to power ... there may be a sell-off,' said James Lord, strategist at Standard Bank in London.