Romania faces the stiffest test

Date: 21/04/05

Romania, the bigger of the two countries to be anchored to the EU by the signing of the accession treaty next week, was a late starter in the reform process.

It has been lagging behind the other candidates negotiating their EU entry ever since the collapse of the communist system in 1989. Failure to implement any serious reform by successive centre-left and centre-right governments and rampant corruption were punished by the electorate in 2000 when the leader of the far-right Greater Romania party came second in the presidential elections, which were eventually won by the Left candidate Ion Iliescu.

But reforms have been accelerating recently, with notable success in macroeconomic adjustment, privatisation and governance restructuring. As a result, the economy grew by an average of more than 5% of gross domestic product (GDP) since 2000 (8% last year) and is expected to grow by 6% this year. Inflation went down from 155% in 1997 to 9.1% in 2004, the first year that it fell to single-digit figures since the collapse of communism. Unemployment oscillated between 6-8%, well below the EU average of 10%. The income per head has increased steadily since 2000 and is now 30% of the EU average in purchasing power parity.

The weight of the private sector in the economy has increased gradually, through the privatisation of larger state-owned enterprises and banks. The share of the private sector in GDP reached 70% in 2003 and will increase, since the authorities' agenda remains unfinished.

But the privatisation process was marred by corruption scandals, which have largely scared away foreign investors. Although foreign direct investment (FDI) grew rapidly in recent years (last year Romania attracted 50% of the FDI in south-east Europe), Romania still lags behind the new EU members in terms of FDI per capita.

On 1 January, the Bucharest authorities introduced a flat rate of 16% for corporate and income tax. The main aim of this fiscal reform was to attract FDI inflows, improve tax collection and reduce the grey economy which was last year estimated at 30-40% of GDP.

The new government, which took office in December, last month blocked the accounts of companies owing money to the state. The unpaid debts of around 3,000 companies to the state budget constituted a major bottleneck in the Romanian economy.

Prime Minister Calin Popescu Tariceanu says the government is committed to reforming and modernising the country's economy. "We are very careful about maintaining the macroeconomic stability: we fixed ourselves an inflation target of 7%, from 9.1% in 2004, we have a target budget deficit which would make many EU countries jealous: 0.7% of GDP."

Tariceanu says he will focus on achieving the objectives set out in the Lisbon Strategy for competitiveness, by investing "more and more in a knowledge-based economy, to create a modern economy".

The previous centre-left government claimed it wanted to create in Romania a "Silicon Valley" of information technology innovation. Tariceanu believes that this is an ambitious project, but acknowledges that the western Romania city of Timisoara, which is a strong academic centre and has the advantage of being close to the border with Hungary, as well as Cluj, in Transilvania, are strong research areas which are likely to "irradiate and spread growth" to the areas around them.

But, despite recent successes, doubts persist about the competitivity of the Romanian economy. Brussels has been critical of the government's handouts to ailing industries, the legacy of a highly subsidised and weak industrial base inherited from the communist era. The European Commission's competition directorate-general gave a negative opinion on closing accession talks with Romania, but the college of commissioners decided nevertheless to conclude talks last December, to prevent Romania's accession being decoupled from Bulgaria's.

But under a clause in the accession treaty, failure to comply with EU demands on state aid could delay Romania's accession by one year.

Romania has important challenges ahead to make its economy competitive. It needs to push ahead with governance reform and in particular with reform of the judicial system. It must continue a large privatisation agenda and reform its agricultural sector which accounts for 40% of employment but only produces 12% of the country's GDP.

Romania, the slow reformer, has to show that the success it has achieved over the last few years was not an accident.

Article looks at the economic and political situation in Bulgaria less than two years before the country's planned accession to the European Union.