IF THE CRISIS IN THE EUROZONE WORSENS IMF: "Romania's economy could contract by 5%"

• The leu risks a depreciation of 15-20%

The severe worsening of the crisis in the Eurozone, which has an average likelihood of coming true, would have a major impact on Romania, as an economic drop of 5% and a depreciation of the leu of 15-20% is possible, the experts of the International Monetary Fund (IMF) warn.

Taking into account the experience of 2008-2010, an economic drop of 5% would be possible, whereas a depreciation of the exchange rate of 15-20% would seriously affect the portfolios of banks, according to the country report drawn up by the Board of the Fund. In the event of a serious worsening of the crisis in the Eurozone, Romania would need emergency liquidity and accessing the stand-by agreement with the IMF may become necessary.

The crisis left "deep scars" in the Romanian economy, and the potential growth of the GDP would need time to recover, according to the IMF. The experts of the Fund estimate a potential growth of less than 2% until 2014 and a gradual acceleration to 3.1% in 2017. The growth levels of 5-6% which existed before the crisis are difficult to achieve in the absence of major reforms, which would attract more people to the labor market and attract investments.

The IMF revised the estimate for the potential growth of the GDP from 2% to 1.4% for this year and from 2.9% to 1.8% for next year. In 2014, the potential growth could amount to 2.2%, to 2.7% in 2015, 2.9% in 2016 and 3.1% in 2017.

Romania has made significant progress in its macroeconomic stabilization, under the two stand-by agreements, but the economic recovery remains fragile, the report says.

The IMF experts said: "It is to be expected that the short-term growth would remain subdued and only a gradual recovery could take place in the medium term, with the risk of a rather negative outlook. Strongly connected to the economic and financial sectors, Romania is exposed to the crisis in the Eurozone. The fiscal and foreign reserves provide a buffer and the banking sector remains strongly capitalized".

The International Monetary Fund revised its forecasts on Romania's medium term economic growth down, from 4% to 3.5%, due to the delays in the implementation of structural reforms and the less than expected capacity to absorb European funds, according to the country report.

In the opinion of the Fund, Romania's main challenges remain ensuring the macroeconomic stability and stimulating economic growth. In that regard, the IMF considers that the main priorities of the Romanian authorities are: maintaining a fiscal discipline to ensure the reduction of the deficit and reaching fiscal sustainability by 2014; the pursuing of a prudent monetary policy; ensuring that banks have sufficient capital and liquidity and the relaunch of growth and of the creation of new jobs through reforms in the area of energy and transports, the reform of the public sector, the increase of the absorption of EU funds and the continuation of the reform of the labor market.

• The impact of accelerating the financial deleveraging: lending would collapse

The impact of an acceleration of the financial deleveraging of the major foreign banks in Romania would be high, lending would collapse, dragging down investments and consumption and non-performing loans would advance severely, according to the forecasts of the IMF.

Also, the pressure on the exchange rate would intensify, and the lenders' financial situation would deteriorate. The consolidation of banks would require emergency liquidity, and, in an extreme case, an intervention may even be necessary to support banks, if depositors were to lose their confidence in the individual lenders.

The deleveraging process of foreign banks has been moderate and orderly in Romania, partially due to the efforts of the European Banking Coordination Initiatives, the IMF experts claim. The estimated high correlations between asset prices in Romania and lending costs mean that the country is vulnerable to an intensification of the crisis in the Eurozone, according to international analysts.

A disorderly deleveraging process of the foreign banks risks leading to a severe shortage of money or loans, pressure on the balance of payments, and loss of reserves, a significant depreciation as well as negative effects on the economy, the report of the IMF states.

So far, an excessive deleveraging process in the countries of Central, Eastern and South Eastern Europe (CESEE) was prevented from happening, partly due to the European Initiative for Bank coordination which encouraged parent banks to maintain exposure to their subsidiaries in the region and due to the ECB'S decision to support the banks in the Eurozone, which helped banks in Western Europe. Compared to other emerging markets, Central, Eastern and South-Eastern Europe saw recorded a larger process of deleveraging, after the collapse of Lehman Brothers in September 2008, the IMF report states. Romania was severely affected by the financial crisis of 2008-2009, as well as by the recent intensification of the crisis in the Eurozone, which caused lending costs to increase, even though they remain lower than in Hungary, but higher than in Bulgaria or Poland. The internal political tensions in Romania have also contributed to the weak performance of the prices of Romanian assets, as well as to the depreciation of the leu.

According to IMF officials, a negative reaction of the population and of politicians to reforms would prevent their implementation, affecting the outlook for growth, and could induce a loss of consumer confidence and of investors, as well as increased volatility on the financial market, including putting pressure on the exchange rate.

The rate of accessing European funds below expectations, a situation which has a high likelihood, would affect the growth forecasts, which depend heavily on the acceleration of the use of European funds. At the same time, the economic advance could be smaller in the medium term, the IMF experts claim.

If the financial markets stopped lending to Romania, a situation which has a low likelihood of happening, the impact of such an event would be moderate, because the fiscal and monetary reserves cover most of the debt which is coming due in the short term. A degree of fiscal consolidation and financing through the IMF program may be necessary.

• The reform of state owned companies would reinforce the outlook for economic growth

The reform of state owned companies will consolidate Romania's long-term growth outlook, but the economy needs massive investments in the next decade, the country report states.

In Romania, the quality of the infrastructure in the key economic sectors, such as energy and transports, where state owned companies are dominant, is weaker than in other countries. Their reformation, an improved corporate governance and a higher involvement of the private sector would lead to better investments in these essential sectors, the IMF report states.

The reformation of the state owned companies could also create a fiscal space for investments in social sectors and infrastructure, to allow all of the Romanians to benefit from these reforms.

Amid the uncertainty in the markets and the risks caused by the Eurozone crisis, such as an acceleration of the deleveraging process of foreign banks, it is important for the Romanian National Bank to continue with the intensive banking supervision and to draw up supplemental crisis preparations, the IMF experts warn. It is important for the National Bank of Romania, in coordination with other relevant authorities, to be prepared to implement measures for the management of the crisis.

• Romania continues to follow a good direction as part of the IMF program

Romania remains on the right path as part of the agreement with the IMF, and all of the performance criteria of the sixth revision of the agreement were fulfilled, except for the reduction of the government arrears, the country report states.

The IMF officials said: "All the indicative targets, with the exception of government arrears have been reached. Corrective actions were taken to reduce the arrears stock and to prevent the accumulation of new ones. The structural benchmarks for the increases in the price of electricity, the integration of the accounting reporting system with the payment system of the Treasury and the preparation of comprehensive amendments to the healthcare legislation have been reached".

In spite of all of the above, the progress in the structural agenda, especially when it comes to the privatization of the public companies, remains slow. As priority steps to fulfilling this requirement, "the Government has made the commitment to launch IPOs in two public companies, and the preparations are at a significantly advanced stage", the document states.

The Board of the Fund considers that the fiscal and monetary policy and the resolute implementation of the structural agenda are necessary to ensure the macroeconomic stability and the acceleration of the growth.

The report states that the fiscal discipline will be necessary, especially in the context of the nearing parliamentary elections, in order to reach the targets in the fiscal program and the achieving of the fiscal stability.

The IMF experts said: "The assumed fiscal policy should lead to consolidation, in light of the inflation risks, the possible capital exits and the pressure on the exchange rate. In the financial sector, where vulnerability of the Romanian banks is great, due to their parent banks, steps are needed to ensure adequate capital buffers and liquidity, the slowdown of the increase in non-performing loans and the completion of the strategy for reacting to the unpredicted events. The strong continuation of the structural reforms, especially in the energy and transports sector and in the public companies sector could provide a greater stimulus to the need for investments and growth. Improving the absorption of the EU funds is a priority for the significant unlocking of the resources which could continue helping Romania to achieve a real convergence with the other European countries".

At the end of September, the Board of the IMF approved the sixth revision of the preventive agreement with Romania, which resulted in the release of a new tranche of 430 million SDRs (special drawing rights), the equivalent of 519.2 million Euros (663.1 million dollars).

The mission of the IMF is scheduled to visit Romania between November 6th - November 14th, to talk to the authorities about the recent economic developments.