BURIED UNDER THE SNOW, BURIED IN DEBT Romania, an adrift "Costa Discordia"

After a month of hard winter, like we've never had in the last 50 years, spring shows its first signs. But not for Romania's economy.

The president's silence over the last few weeks showed us that things aren't looking so good when it comes to the fight against the crisis. No, I am not talking about the silence when it comes to the protests in the University Square and in the rest of the country, we are talking about the way he chose to ignore communicating the macroeconomic forecasts prior to the publication of the results by the National Statistics Institute.

Preliminary data on the evolution of the economy in Q4 2011 shows that Romania is far from being in "excellent shape", like Jeffrey Franks said in a recent interview for "BURSA". The authorities' moderate triumphalism, on the success of the austerity program, has proved its uselessness ever since mid-2011.

In an article published in June 2011 (author's note: "How can we exit the recession if we didn't even exit it?", BURSA, June 27th, 2011), we showed that the exit from the recession is an illusion, considering that the increase in stocks heavily distorts the economic growth indicators.

At the time I also made an "optimistic" forecast: "If the current trends persist, in the optimistic case, this would lead to seeing a first negative quarter in Q4 2011 and the confirmation of the recession after Q1 2012". The preliminary data from the National Statistics Institute have confirmed this forecast, and the publication of the first sectoral estimates, on March 6th 2012, will show us how well the economy is really doing.

For now, data for December 2011 shows that the industry has seen a month to month slump of 16.9%, according to seasonally unadjusted data, and a quarterly drop of 16%, after advancing 5.1% in Q3 2011.

The quarterly drop of the GDP of 0.2% almost certainly conceals a new increase in inventories. After the first three quarters of 2011, the net increase was 23.7 billion lei (see chart), compared to 19.1 billion lei in the entire year of 2010. And in real terms, stocks were almost three times higher than those of the entire year 2010. (see chart)

In the manual for the methodology of calculating the GDP, of the Bureau of Economic Analysis, it says that inventories are one of its most volatile components, and their accelerated rise can indicate a future drop in output.

The BEA also defines the structure of inventories, made up of finished products, unfinished products and raw materials or materials acquired by suppliers.

Regardless of the current stage of the inventories in Romania, in the coming quarters they will see a major correction, with a significant negative impact on the GDP.

In this extremely unfavorable context, the last thing we needed was for winter to go berserk, burying us in snow and bringing transports to a halt. But we have an "optimistic" angle for this one: the government and the National Bank will mercilessly condemn this "scapegoat", which once again covers up their incompetence.

And if the thick layer of snow was not enough, the IMF is ready to "help" us. The openness which the IMF shows when it comes to the proposal to raise the wages of public sector workers and pensions means that the Fund is ready to get to work trying to make things look better in Romania.

It does not matter that such a hike is unsustainable, without an initial salary increase in the private sector. And that sector can't grow, as it is still being choked to death by debts, taxes and absurd regulations. Only one thing matters in the 2012 electoral year: democratic elections need to produce an "obedient" outcome, which would convince the population that there is no greater joy than paying off the debts which the authorities have acquired in the name of an illusory prosperity.

One step in that direction has already been taken. The government has announced that we have managed to keep within the budget deficit target for 2011, without going too much into details. But...

Meeting the budget deficit target agreed with the IMF was only achieved on the condition of not including arrears in the expenditure categories. According to the oversight report of the IMF of January 2012, by the end of Q3 2011 arrears had reached 24.6 billion lei, of which 3.6 billion were "discovered" on the occasion the last oversight mission alone. Added to the official budget deficit, that gives us a deficit of 8.8% of the nominal GDP estimated for 2011. "Excellent shape" indeed!

Given the fact that Europe's economy is in just as "good" a shape, amid the negative impact of the foreign trade, including that of Germany, where will the economic growth come from in 2012?

The answer to this question needs to come from the new government and from the National Bank, which has just greatly stepped up the money presses, even as it suddenly realized the harmful effects that the nonsensical taxation has on the business environment.

Unfortunately, this "finding" of the officials of the NBR comes much too late, especially considering that they had their independence as an institution and the monetary policy instruments which would prevent the current disastrous state of the economy and mitigate the effects of the incompetence of the government.

The laments of governor Isărescu, concerning the dramatic drop of foreign investments over the recent years also come too late. A recent IMF study (author's note: "Capital Inflows, Exchange Rate Flexibility, and Credit Booms", Working Paper No. 12/41, February 2012), shows that inflexible exchange rates are usually associated with a predominance of foreign currency loans in an economy: "massive inflows of foreign capital allow banks to raise their loan portfolios, and they will then try to avoid currency imbalances by lending in foreign currencies".

Authors (author's note: Nicolas Magud, Carmen Reinhart and Esteban Vesperoni) also used Romanian data from the 1999 - 2008 period, and their conclusions are a scathing criticism of more than just the exchange rate policy of the NBR: "Our conclusions suggest that countries with a less flexible currency system benefit the most from the regulations which reduce the bank's motivation to appeal to foreign financing and loans denominated in foreign currencies; these regulations include the level of the minimum reserves for foreign currency loans, specific liquidity requirements for each currency and higher capital requirements for loans denominated in foreign currencies".

Not one of these recommendations was followed by the policy of the NBR during the period when lending was booming, and once the euphoria of growing debt was spent, the myth of the irresistible attraction which our economy had for foreign investors also disappeared.

Now, the governor of the NBR is telling us that "winning the confidence of investors is hard to do" and that the idea of a total change, of a new revolution is not relevant, and that the "solutions to create a virtuous circle are the small steps and consistency", according to the press agencies. "How could a revolution happen...As long as our own people are in power, who's gonna take the time to make a revolution?", like the character of a Romanian theater play used to say.

Unfortunately for the Romanian authorities, the time for small steps is long gone. The reconstruction can not happen amid an institutional, monetary and fiscal structure similar to the one which led to the collapse of the previous system. Measly tax cuts are no longer sufficient now, and the concept of public spending needs to be completely eliminated, because all it does is feed pointless illusions.

The revolution we need is that of economic freedom, in an institutional environment which would no longer allow the state to confiscate the fruits of labor with impunity, both through abusive direct taxation as well as through the constant reduction of purchasing power.

Could economic freedom also be a remote illusion? Let's hope not, let's hope that we only have a little while left until the conditions which would allow a new beginning for Romania are ripe.

Otherwise, all that will be left will be a rudderless economy, which will be "rescued" just like Greece was, when it crashes.

Note: the Article represents the author's point of view, does not reflect or imply the opinions of the institution that employs him and does not represent an investment recommendation.