EIU Report : VAT increase and income tax seem unavoidable for the correction of the budgetary deficit

VAT increase and income tax for 2010 is « unavoidable » so that the Romanian government could reach the targets of the budgetary deficit agreed with IMF, despite the negative impact the measures could have on consumption expenditure, according to a report of the Economist Intelligence Unit (EIU).
« The government has established some measures with the European Commission to restrict budgetary deficit to 6% out of the GDP ( or 6.5% of GDP after the EU methodology) in 2010 as compared to the initial agreement who included a target of 3.6% of GDP. The agreement requires the government to make significant reductions in the public sector payment. It is unavoidable for the government to be obliged to increase VAT or income tax to reach these targets despite the negative impact of the measure” the EIU report says.
For 2009, the budgetary deficit target is 7.3% of GDP, revised since the previous estimate of 4.6% of GDP. At the same time, the Romanian authorities agreed with IMF on an estimate for GDP contraction by 8 – 8.5% for this year, against the previous projection of 4.1%.
« The package ( foreign financing) is under conditioning which links the IMF and EU stages to the budgetary deficit and requires the government to reduce expenditure with salaries in the public sector. Although the IMF will agree to higher deficit for 2009 and 2010 against the initial agreement, the EU could pressure Romania into bringing the budgetary deficit under 3% of GDP in 2011, the report says.
At the same time, the analysts expect social tension, as economic conditions worsen and unemployment rate increases ( estimated at 7.6% at the end of this year) but conflicts within the coalition as presidential elections come close.
« The decline of the government popularity and the worsening of the economic situation will increase the risk of social tensions. The possibility of new elections during the next two years or the forming of a new coalition after presidential elections cannot be eliminated” the EIU report says.
As regards the deficit of current account, the EIU analysts estimate an adjustment up to 4.8% of GDP before the end of 2009 so that in 2010 the deficit of the payment balance could reach 4.9% of GDP.
Last year, the current account deficit of Romania reached 12.3 of GDP.
EIU : The leu could be overvalued and it is vulnerable to the worsening of the political and economic situation
The leu could be overvalued and could be vulnerable to the depreciation pressure if the economic or political situation worsens dramatically over the next months, EIU considers, in their latest report anticipating an exchange rate of 4.1 leieuro at the end of 2009.
« It is possible to be significantly overvalued on the basis of estimates regarding the balance of exchange rate. The leu could be vulnerable to depreciation pressure if the political or economic situation worsens dramatically over the next months” the Economist Intelligence Unit report shows.
The EIU analysts observe « possible problems for competitiveness in Romania “ome from the difference between the evolution of the leu and other currencies in the region which depreciated while the leu kept its stability during the recent period.
« BNR announced formally that they will intervene to prevent an excessive depreciation and it will be helped by the international foreign currency reserves” the EIU analysts say.
To this purpose, the EIU estimates an exchange rate of 4.1 leieuro at the end of this year so that at the end of 2010 the leu could strengthen to 4.06 leieuro.
At the same time, the analysts say that leu stability as well as the disinflationist tendency created conditions for the reduction of the monetary policy interest.
« They expect that interests drop but modestily during 2009 and other reductions are possible for 2010, once the inflation drops and interests on the interbanking market go towards BNR rates” the report says.
On the other hand, EIU estimates that inflation drops at the end of this year to 4.1% “ only if salary policies and fiscal policies will be restricted according to the budget and salary increases are reduced”. For the end of 2010, analysts estimate an inflation of 3.1%. “ Despite all this, the level is still under that in the majority of EU member states” the report says.
EIU: Recession in Romania likely to drag well into 2010
Romanian economy is likely to keep shrinking by 7.5% in 2009, and an economic revival could take hold in 2010, with 1% growth in GDP, according to forecasts of Economist Intelligence Unit. However, the country may run a higher-than-expected budget deficit which would drag the recession well into 2010, “especially if additional austerity measures will be needed”. “We expect a further drop in GDP quarter-on-quarter in July-September as well, as domestic consumption will continue to slow down. An economic revival is likely to take hold in fourth quarter which will partly offset the annual economic contraction as a result of base effect. Therefore, we forecast a decline in real GDP by 7.5% in 2009”, reads the EIU September forecast report. In 2010, EIU expects a “modest” recovery, with a GDP growth as little as 1%, “adjusted by the early 2009 exchange rate correction”. The paper says the 2009 and 2010 economic decline in the euro zone countries will lead to a worsening of Romania’s main export markets and FDI inflow will be deteriorated by the difficulty in attracting external financing and in credit tightening. “The recession may worsen or last even longer than we have predicted in our basic scenario, especially if additional austerity measures will be needed in 2010 and 2011 to contain budget gaps within EU target range”, report shows. “However, the external financing package could help the government bridge the budget and CA gap and should head off a higher contraction in output”, said EIU.

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