Published: April 9, 2009
EU, IMF, World Bank and EBRD are joining forces to support Romania with a €20bn financial support package, it was announced on March 25.
The funds will be disbursed over the next two years. During this period, the IMF will lend Romania €13bn, the EU will lend €5bn, the World Bank €1-1.5bn, and the EBRD up to €1bn.
The international funding package will aim to cushion the effects of the sharp drop in capital inflows while implementing policy measures to address the external and fiscal imbalances and to strengthen the financial sector.
Romania is the third Eastern European EU member to receive external support from the IMF and EU, after Hungary and Latvia. In all of these cases, attached conditions are consistent with moving countries toward compliance with the Maastricht criteria. Romania’s target is to join the eurozone is 2014.
The root of Romania’s problems lies in its heavy borrowing from abroad. Neil Shearing, emerging Europe economist at Capital Economics, says: “Romania in particular has been borrowing very heavily from abroad in order to fund developments over the past five years. The credit conditions in the local economy have become more and more difficult. They can no longer borrow through abroad to fund consumption and investment. That has a direct impact on GDP growth. More generally, this means that they have got a lot of short term debt that has to be repaid. In the meantime, the economy is on course to shrink by 7.5% this year.”
Svitlana Maslova, analyst at Barclays Capital, thinks that domestic demand is likely to weaken significantly. She says: “We estimate that the current account deficit will narrow to 8% of GDP in 2009 and 3% in 2010, as domestic demand contracts. This is probably more important for the country than exports, which typically account for only 30% of GDP.”
Maslova explains that domestic demand is being hit by a correction in credit growth, as the Romanian banking sector is experiencing similar difficulties to banks in the rest of Central Europe. “The economy’s indebtedness in Romania is low (30% of GDP at the end of 2008) but has risen quickly, causing domestic demand to rise in recent years,” Maslova says.
In the past six months, the Romanian leu has fallen by 16%. Since Romania has a floating exchange rate to the euro, the central bank has been intervening with regards to fluctuations. But with the bailout loans come conditions attached.
Shearing of Capital Economics explains: “The national bank will no longer be able to intervene under the conditions of the bailout. Not many details are known, but one of them will be that they sign up to a more flexible exchange rate regime. Under those circumstances, further falls are almost inevitable.”
From a fiscal perspective, Shearing thinks that implementing the programme is going to prove challenging. “The recession in the real economy is going to get much deeper and much more painful,” Shearing concludes.
Maslova thinks that the package is likely to be sufficient to plug the external financing gap this year. However, the risks, particularly related to the banking sector’s refinancing, are likely to stay.
In February 2009, the largest multilateral investors and lenders in Central and Eastern Europe – the EBRD, the EIB and the World Bank – pledged to provide up to €24.5bn to support the banking sectors in the region and to fund lending to businesses hit by the global economic crisis.