Some scary parallels…


What’s going on in Romania?

What’s going on in Romania? Where can we Brits still afford to go on an overseas holiday? This was the question vexing some of MoneyWeek’s finest minds last Friday. The post-election pound was looking sickly. And our foreign spending power was visibly ebbing even against the Greece-afflicted euro. So how about Romania? You get as much now for your sterling against the Romanian leu as you would have got in 2007. And the country boasts some well worth-a-visit classic castles and mediaeval towns.

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Why is Romania so cheap? Because the economy really hit the skids last year. And it’s still paying the price. Romania swung from boom to near-bust very fast. In 2007 and 2008 the economy grew by 8% a year, but last year it shrank by more than 7%. The country’s steel and car industries were hit hard by the global recession. Foreign investment plunged, and foreign debt climbed. And commercial property prices, which had been getting dangerously close to bubble territory, tanked by as much as 40%.

There are some scary parallels between the UK and Romania

Nasty. But what’s really scary is that there are some striking parallels between Romania and the UK. The Romanians’ cost of living is rising at just over 4% a year. That isn’t too far above the 3.4% inflation level that we’re currently enduring. In Romania, spending on state wages, pensions and social security benefits accounts for 62% of the government’s budget. Britain’s welfare state – health, education and social security – consumes almost two-thirds of government spending. And on some comparisons Britain is actually rather worse off.

The Romanian state payroll swallows up 9% of GDP. That’s „twice as high as it should be”, according to experts, says Luiza Ilie for Reuters. Yet in the UK last year, the total public sector wage bill added up to almost 11% of our annual output. And last year’s Romanian budget deficit was below 9% of GDP, which was some way lower than our 11.4% shortfall.

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So we’ve nothing at all to feel smug about. In addition, as I’ve already noted, Romania – unlike Greece – still has its own currency. So it’s been able to perform the British trick of letting this slide in value against the likes of the euro. This means the debts it’s run up in leu will cost it less to pay back in euro terms. Yet – and those who breezily say, „oh Britain can just print its own currency to repay its debts” should take note – having its own currency still didn’t stop Romania from running out of money. Yes, it could have just printed more. But that way lies hyper-inflation and total pariah status in the bond markets. If you want to turn a troubled economy into a textbook basket-case economy, that’s the route to take.

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Romania, sensibly, didn’t go down that road. So just over a year ago, it was forced to go cap in hand to the IMF for a €20bn loan. Thanks to the IMF deal, yields on five-year Romanian bonds have dropped sharply over the last 12 months, from double-digit levels to below 7%. That’s good, because it’s cut down the cost of state borrowing.

Greece’s troubles are tiny compared to Romania’s

But to keep bond investors onside, Romania has to make sure that the IMF’s moneymen are happy enough to hand over the next chunk of cash. This means the country’s citizens will really have to tighten their belts. And it makes what Greece is facing look like chicken feed.

Romanian President Traian Basescu is slashing public sector wages by 25%. All salaries, right down to those at minimum wage levels, will be hit. Meanwhile, jobless benefits and pensions will be chopped by 15%. „The state sector is like a fat man of 200kg sitting on the back of a 50kg little man who is the real economy”, as he neatly puts it.

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The bottom line is that this year, Romania’s budget deficit is now forecast to be below 7% of GDP, compared to a likely UK deficit of 12%.

Sure, Romania’s trade unions aren’t going down without a fight. They’ve just threatened a Greek-style wave of strikes to bring public services almost to a complete standstill. But they’re fighting financial gravity. The Romanian government has no choice about slashing costs. „The programme to cut public expenses is inevitable”, says Basescu.

by David Stevenson („Money Week”)

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