The International Monetary Fund was “very impressed” with the Romanian government’s commitment to its bailout agreement after it raised a sales tax to win approval, said Jeffrey Franks, the fund’s mission chief to the country.
The lender’s board of directors agreed yesterday to disburse $1.15 billion to Romania, which increased its value- added tax rate by 5 percentage points and cut wages as of July 1 to reach the deficit target attached to the loan. The European Commission, one of the country’s other lenders, will probably unlock 1.15 billion euros ($1.45 billion) in payments in September, Franks said in a phone interview from Washington today.
The government, relying on 20 billion euros in loans from the IMF and the European Union to finance its deficit, raised the VAT to 24 percent after the constitutional court threw out a proposal to cut pensions to narrow a budget deficit target to 6.8 percent of gross domestic product. The austerity program is undercutting the government’s support at a time it is struggling to pull the country out of a stubborn recession.
“Broadly speaking,” IMF directors “were very supportive of Romania’s efforts, in particular, several directors mentioned that they were very impressed,” said Franks. “There are certain concerns that the economy is continuing to be very sluggish and they want to make sure that the authorities continue in their efforts to maintain the reform process going forward.”
The east European country’s economy, mired in the worst recession in two decades, will probably contract at least 1 percent in 2010, more than previously forecast, Finance Minister Sebastian Vladescu said on June 29. There will probably be “higher inflation and a different exchange rate” because of the increase in VAT, according to Vladescu, who declined to give a figure because the ministry is still working on a new forecast.
The IMF and the government estimate GDP will contract as much as 0.5 percent this year after shrinking a record 7.1 percent in 2009. The central bank forecasts year-end inflation will be 3.7 percent.
In addition, the VAT increase will have a “significant one-time effect on inflation,” Franks said. The inflation rate will probably rise to 7 percent to 8 percent at the end of 2010 from 4.4 percent in May, he said, with the impact probably disappearing in 12 to 18 months.
Franks said the IMF is maintaining its economic contraction forecast. A mission will visit Romania at the end of July to review the country’s progress under the bailout loan and will do a revision at that time.
“We do not think there will be much additional negative effect on GDP growth from VAT compared with the expenditure cuts that were previously planned,” Franks said. “So the impact may be actually slightly less negative and the reason for this is because pensioners are quite likely to spend all the money that they receive whereas if you put a tax on the broader population then they cut spending by somewhat less.”
Frank said Romania has “already done very, very large measures to attempt to reach the deficit target,” including cutting public sector wages by 25 percent and some transfer payments by 15 percent,
“Those are very significant measures,” Franks said. “At this time, I think we’ve seen very important steps from them, it’s likely to be sufficient, but we’ll have to calculate this during our next mission, as we always do, to see what is happening with revenue and expenditure as they come in.”
The leu strengthened as much as 1.2 percent to 4.2891 per euro, the most since May 2009, and traded 1.1 percent higher at 4.2943 in Bucharest yesterday, the largest rally among more than 170 global currencies tracked by Bloomberg.
The currency tumbled 3.5 percent in three trading days ending June 29 to its weakest level against the euro on record after the court ruled the proposed pension cuts were illegal, sparking speculation the next disbursement of the IMF loan will be delayed.
The currency has since recovered almost two-thirds of those losses on speculation today’s IMF meeting indicated Romania may be nearer to getting funding.
“The markets have been nervous because they were concerned whether the measures will be approved, whether they would be implemented, whether the IMF disbursement will go ahead,” Franks said. “I would anticipate that the vote of the IMF board yesterday would give them some confidence in believing that the program is on track and that the authorities will execute the measures they had agreed and therefore there is no reason for concern at this time.”