Halfway down the Danube

A Few Words About Romania's Economy

Right now Romania's economy is doing OK. Yes, there are lots of problems, some of them very serious, but (with one exception) the "macroeconomic fundamentals" look pretty good.

Unemployment has been falling for the last couple of years. Today it is around 7.5%, which seems high to Americans but is pretty good for Europe. (Yes, that's the official statistic, and yes, the real figure is almost certainly higher. But it's clear that unemployment has been falling for a while now as the economy expands.)

Inflation is running around 15 percent per year, which is high but much much lower than it was; it was 45 percent just a few years ago. The currency is pretty stable. The banking sector, after a lot of difficulties, now seems to be in good shape, and there's a lending boom. Foreign direct investment is rising, albeit from a very low base. The government's budget deficit is big but at least it's not growing any more. Overall, the economy is growing between 4% and 5% per year, and has been for almost three years now.

Mind, Romanian wages have not risen along with growth. The average real wage, adjusted for inflation, only rose by about 1.6% in 2003. Optimists say this is because Romanian productivity is going up, so of course output is rising faster than wages. Pessimists say that Romanian workers, especially in the public sector, will demand big wage increases soon, and that this will result in wage-price inflation. But that's a story for another time; and at least real wages are rising, which is not true everywhere in this region.

So, good news, right? Well, maybe. There are two areas of concern.

1) There are probably a lot of "structural problems" lying in wait for Romania. Like reefs below the placid surface of a lagoon, these are problems that may rip the bottom out of Romania's economy.

To name just a few, Romania has painfully high taxes; a bloated and inefficient public sector that still controls nearly half of the country's economy; and a bad reputation for corruption. None of these have crippled growth so far, but they could all act to put a sudden brake on it.

I may talk about these in more detail some other time. For now, let's talk about the other big problem. Here comes some discussion of economics, which will certainly be hard for some readers and ridiculously oversimplified for others. I'd rather err on the side of simplicity, though. (Beat me up in the comments section if you must.)

2) I said there was one exception. There's one macroeconomic indicator that's suddenly going in a worrying direction, and that's the current account deficit. In non-economist language, that means Romanians are importing a lot more than they are exporting. This deficit has been large for a while, but in the last few months it has been growing explosively. It was expected to be about 4.8% of gross domestic product in 2003, but it looks like it will be more like 6.5%.

There are several reasons for this. One is that Romania's economy is growing, so businesses are importing a lot of machines and other tools for doing business. Another is that Romanians are buying a lot of foreign consumer goods. A third is that the harvest this year was very bad, so Romania must import a lot of food.

Okay, so what does this mean? Well, it means that eventually the Romanian currency, the leu will have to drop in value. After all, people don't want lei (to buy Romanian goods) as much as they want euros or dollars (to buy everything else). So there'll be downward pressure on the leu. In fact, there is already downward pressure on the leu.

This gives the Romanian government two choices, neither of them good.

1) It can allow the leu to fall. But this will make foreign goods more expensive, so it will make Romanians feel poorer. This is politically dangerous, especially in an election year. Oh, and there's also the risk of a panic if the leu falls too much, too fast.

2) It can defend the leu. For instance, it can raise interest rates. If interest rates on lei-denominated investments are higher, then people will change euros and dollars into lei to buy them.

Unfortunately, raising interest rates is a good way to stop growth. Interest rates in Romania are already pretty high. (Those figures include inflation, so you need to subtract ten or fifteen percent. Still.) Raising interest rates further means fewer businesses borrowing money, so less investment, so less growth.

Right now the government is sort of wiggling around trying to find another way. For instance, working on the assumption that consumer spending is the problem, they are considering raising excise (import) taxes on certain "luxury" goods, and also trying to make consumer credit more difficult to obtain.

This is actually not a bad idea -- assuming they have identified the problem correctly. If they can gently slow consumer spending, and the trade deficit self-corrects in the next six months or so, then perhaps they can escape without either a big interest rate hike or a big drop in the leu.

(Okay, this is my first try at a "serious" post here, and I don't know if our readers find this sort of thing interesting at all. So comments, even critical ones, are very welcome.)

Posted by douglas at December 10, 2003 10:09 AM