Spring 1998

SUMMARY
Romania was thrown into renewed political turmoil in March 1998, when Victor Ciorbea (Christian Democrat party chief and Prime Minister) gave in to mounting calls to resign. Radu Vasile was appointed as the country’s Prime Minister-designate by a secret party ballot. Vasile will face the same pressures both from within his own party and other coalition parties, as well as from abroad, to deliver where Ciorbea failed. This means forcefully pressing ahead with reforms that, though politically unpopular, are vital if Romania is not to descend into further economic decline. Vasile must bring Romania’s political parties to a common denominator.

Lost momentum of macroeconomic adjustment, supported by structural reform in a climate of tight budgetary policy, must quickly be regained. This must include accelerated privatisation of state-owned, loss-making enterprises and banks, and restructuring of the regies autonomes. The sale of flagship telecom monopoly Rom Telecom in 1998 will therefore be seen as a litmus test of the new government’s commitment to divesting state assets to more efficient private sector owners.

At this point, it is extremely difficult to gauge the potential impact of recent changes. If the new coalition adopts IMF-agreed reforms, further economic stabilisation and market liberalisation measures could still make Romania an attractive investment location, in the longer term. Relatively low indebtedness (28% of GDP in 1997), compared with other countries in the region, and low wage levels, could help attract inward investment. Until the 1998 budget receives Parliamentary approval, however, economic reforms are effectively on hold. The risk remains that structural reforms could be diluted by over-generous concessions to labour unions, re-igniting inflation.

Despite political infighting and brinkmanship, which has stalled reforms, Romania’s economy should return to positive growth in 1999. After a severe 6.6% output contraction in 1997, Romania is forecast to have zero growth in 1998 and to grow by 3% in real terms in 1999. Significant inflation and currency exchange risks remain, however. Average inflation may fall to 70% in 1998, at best. External balances will remain negative, as imports outstrip exports for the next year or two; the current account deficit is expected to exceed 4.5% of GDP, and foreign debt payments may reach US$2bn in 1998. Bucharest still faces the prospect of a large funding gap.

Commercial reform of agriculture, vital to raising farm output and productivity and lifting low living standards, remains stalled, blocked by incompetence, corruption and vested interests which stand to lose out if measures are put in place to control the monopolies that currently operate in inland distribution and exports, and basic land reform. The inaction is costing the Romanian economy an estimated US$9bn a year.

ROMANIA - Key Economic Indicators

	1995	1996	1997e	1998f
Real GDP (% change)	7.1	4.1	-6.6	0.0
Nominal GDP (US$bn)	35.7	35.5	34.8	42.5
Industrial production growth (%)	9.4	9.9	-5.9	2.0
Consumer price inflation (%, annual average)	32.3	38.8	154.8	70.0
Consumer price inflation (%, year-end)	27.8	56.9	151.4	52.5
Nominal wage growth (ROL, % change)	48.9	51.9	97.8	29.9
Change in real wages (%)	12.6	9.4	-22.4	-18.8
Unemployment rate (%)	9.5	6.3	8.8	11.0
Budget balance (ROL bn)	-2,969.7	-5,359.2	-7,000.0	-6,000.0
General govt balance (ROL bn)	-1,886.6	-4,161.6	-11,500.0	-14,500.0
Budget balance (% GDP)	-4.1	-4.9	-2.8	-4.0
General govt deficit (% GDP)	-2.6	-3.8	-4.6	-3.6
Exchange rate: Leu/US$ (end-year)	2,578	4,035	7,900	9,250
Merchandise exports (US$bn)	7.9	8.1	8.4	8.8
Merchandise imports (US$bn)	9.5	10.6	10.2	10.5
Trade balance (US$bn)	-1.6	-2.5	-1.8	-1.7
Current a/c balance (US$m)	-1,774.0	-2,571.0	-2,011.0	-1,805.0
For’gn Reserves (US$mn)	1,380.2	855.2	2,530.0	3,000.0
Gross external debt (US$bn)	6.6	8.3	10.3	10.2
External annual debt service (US$m)	1,366.0	1,250.0	1,800.0	2,000.0
Debt service* (%)	17.3	15.5	21.4	22.7
Gross foreign debt/GDP (%)	18.4	23.2	29.5	24.0
Note to table: * debt service costs as percentage share of exports of goods & services; Sources: IMF, EBRD, CAIB, F&C, EIU, GML estimates/forecasts.

POLITICS: Ciorbea falls on his sword
At end-March 1998, Prime Minister Victor Ciorbea, aged 43, handed in his resignation after intense pressure from within his own party to step down, and after the IMF had expressed concern that Romania’s political impasse was hampering reforms and passage of the 1998 budget. The budget’s passage was held ransom, first by the Democratic Party (the junior coalition partner), and then by the Liberal party, both demanding the PM’s resignation. Ciorbea’s departure is bittersweet in some respects. His government had started with so much promise in 1996, but the reform programme it had initiated eventually appeared to overwhelm it. President Emil Constantinescu, who comes from the same party as Ciorbea, had repeatedly mediated in the country’s political crisis and firmly backed his Prime Minister. Constantinescu was said to be considering new polls, though not before next year. Under the country’s constitution, fresh elections are not due until 2000.

Romania’s reform process, based on structural reforms agreed with the IMF, is running well behind schedule. Backed by a solid Parliamentary majority, the government had started to close loss-making enterprises in 1997, but lost its grip on reforms in the second half of the year in the face of increasing resistance from powerful labour unions. Of 17 state-owned companies earmarked for closure in August, the list was whittled down to 12. Today, big state industry remains largely intact, crowding out opportunities for private sector development. The State Ownership Fund (SOF) admitted in March 1998 that there had been no important privatisations this year owing to the government’s dithering on reforms and its internal divisions. Unions have managed to block inefficient state firms from being restructured or closed down, and the Communist-bred bureaucracy remains as opposed to reforms as ever.

In December 1997, Ciorbea, an ex-union boss, attempted to push reforms back on track and to break the privatisation logjam, announcing the replacement of eight Cabinet Ministers and the creation of a new position to head the Privatisation Ministry. Key changes were seen in sectors related to economic reform. Ciorbea brought into government three non-aligned technocrats, in the hope that this would remove party politicking from the reform process. New faces included central bank economist Daniel Dianu (Finance), Ilie Serbanescu (Reform) and Marian-Valentin Ionescu, former President of the National Privatisation Agency (NPA) and counsellor to President Constantinescu (Privatisation). Other changes saw former Finance Minister Mircea Ciumara move to Industry & Trade, while the Education, Health, Youth and Sports, Environment, Forests and Water Ministries also saw a reshuffle. A Public Relations Minister was appointed. Ministers who were considered specialists in their fields (finance, reform and privatisation) were given the task of tackling key areas of the reform programme. But the reshuffle failed to impress Petre Roman, who chairs the Senate, Romania’s upper house. Roman, a Social Democrat, had long wanted to oust Ciorbea, whom he saw as a threat to his party’s strong ties with Romania’s business and banking community. Planned farm reforms and bank privatisations threatened to cut off the Social Democrats from their financial backers.

When the Social Democrats threatened to quit the coalition unless Ciorbea resigned, the PM offered to step down. The offer was rejected by his own party, the National Peasants (one of three parties in the senior coalition grouping, the Democratic Convention). In January 1998, a Social Democrat party gathering voted overwhelmingly to withdraw from the coalition. Roman took his party out of government, though not into opposition. The Social Democrats, he insisted, would support reforms from Parliament.

Roman is notoriously ambitious, and was once an ally of PDSR leader Ion Iliescu, who stalled on reform for years. His party lacks broad appeal and would have little future outside of government. While support for Ciorbea had slumped, opinion polls suggested support for the Social Democrats had fallen even more, though latest polls indicate the party’s fortunes are recovering. Equally, the Social Democrats have no obvious allies among the ranks of Romania’s opposition parties and cannot entirely be trusted with pursuing reforms which may threaten the vested interests of some of the party’s leading figures. Senior party members and activists in the provinces have grown increasingly restless. Even after Ciorbea’s ouster, however, the Social Democrats must realise that further attempts to scupper reform could carry a high political cost for the party.

Much of the criticism levelled at Ciorbea reflected his poor handling of internal party squabbles, which had put a brake on reform when he failed to quell disputes between the Finance, Industry and Reform Ministries. His political skills were again called into question in the badly managed Cabinet reshuffle of December 1997, alienating Social Democrat support after dismissal of two of their Ministers. With Ciorbea out of the picture, the Christian Democrats elected 55-year old Radu Vasile, the party’s Secretary-General, as the country’s new Prime Minister-designate, after his nomination in a three-way race, decided by party chiefs in a secret ballot.

Vasile, whose appointment improves prospects of breaking the political stalemate, was given until April 1998 to form a new coalition cabinet and draft a government programme, to put reforms back on the fast track and restore economic growth. He is on better terms with the Social Democrats than his predecessor, and is viewed as leading a reformist wing within the Christian Democrats. Vasile does not get on with President Constantinescu, however. Having pulled their Ministers out of Ciorbea’s cabinet, the Social Democrats have now returned to the coalition. To form a more stable administration, Vasile will face the daunting task of blending his Christian Democrat’s calls for the return of property, seized by the Communists after the Second World War, with the Social Democrats’ demands for a clear reform schedule to mend the economy.

Vasile immediately started talks on forming a new Cabinet with the same four parties that pooled forces 15 months ago to oust the left (the Christian Democrats, Social Democrats, Liberals and ethnic Hungarians). Key economic jobs were assigned to two Christian Democrats - Ioan Muresan (Reform) and Sorin Dimitriu (Privatisation) - while the Social Democrats received six portfolios, including Radu Berceanu as Industry & Trade Minister. Daniel Daianu retains the Finance Ministry portfolio. The new Cabinet also includes Liberals and ethnic Hungarians. Vasile’s honeymoon period will be brief, however. He will face the same pressures as Ciorbea to accelerate reforms and deliver results. If he fails to gain broad-based support from coalition members and if new elections are called, parties in the ruling coalition might lose ground to the ex-Communists and to a resurgent right led by Vadim Tudor, a nationalist heading the Greater Romania Party. In that event, no combination of parties might then be able to govern.

RECENT HISTORY: Ambivalent on reforms
For the period since the regime of former Communist dictator Nicolae Ceausescu was disbanded in December 1989, until the November 1996 elections, Romania was led by the same President - Ion Iliescu - and more or less the same social democratic government, comprising a disparate coalition led by the Party of Social Democracy (PSDR), of which Iliescu was a member. The largest party in the coalition, PSDR, was formed from a split in the National Salvation Front (NSF) which had taken power immediately after the coup and which comprised former officials who had fallen out of favour with Ceausescu. Although the party embraced the need for reform, it has not proceeded as fast as in other former Soviet satellite states such as Poland, Hungary, and the Czech and Slovak Republics.

The first post-Communist elections were held in May 1990 and gave the NSF a resounding 66% of the Congressional vote and 85% of the Presidential vote. It had already reversed some of Ceausescu's most unpopular policies and now stood for gradual reform, with which it was in tune with a majority of the electorate. By contrast, opposition parties favoured a more radical transition to capitalism, but not only was this unpopular, the message was also badly articulated by a disunited and poorly organised collection of parties.

In second place was the HDUR party, representing the interests of Romania's 1.6 million-strong Hungarian minority population. Decisive though the election result was, it did not prevent sporadic protests at even gradual industrial reform, against the background of a deteriorating economy. An attempt by the then Prime Minister Petre Roman to accelerate reforms in 1991 provoked widespread protests and his ultimate resignation. A new government, with the NSF in alliance with one of the traditional parties - the National Liberals - assumed power. Even so, the opposition recorded strong gains in local elections in early 1992. As pressure on the NSF grew, its conservative faction, under President Iliescu, formed a new party, later to become the PSDR.

New elections were held in September 1992. The PSDR was again the largest single party but now with only 28% of the vote. Iliescu retained a strong personal following, however, and was easily re-elected President. The second placed party - the centre-right Democratic Convention (DC) - was a coalition of 18 parties, which won 20% of the vote and stood for faster reform. The rump NSF came third with just 10%. A minority government was formed in November 1992 under PM Nicolae Vacaroiu, an independent, although he later joined the PSDR. His government had increasingly to rely for support on ultra-nationalist and neo-communist parties, an alliance which became increasingly difficult.

The minority nature of the government inevitably inhibited the pace of reform but policy nevertheless retained a reformist slant, in furtherance of Romania's strong desire to integrate with the West, and in particular to join NATO and the EU. Romania signed an association agreement with the EU in 1993 and was the first country to be accepted into NATO's partnership for peace in 1994. Its border with Serbia-Montenegro also gave it an important strategic role during the war in Bosnia, during which Romania made strong efforts to comply with UN sanctions against Serbia. Romania was turned down for ‘fast-track’ membership of both the EU and NATO when accession talks for selected countries commenced in 1997.

Romania is keen to ensure that the West's policy toward Eastern Europe should be even-handed, and is particularly concerned lest Hungary achieve NATO and EU membership before Romania, which appears probable, given Hungary’s impressive macroeconomic turnaround in recent years and stable politics. If this were to happen it could cause friction between Romania and Hungary, and would be unpopular with the Hungarian minority. Although NATO membership remains some way off, Romania recently received strong expressions of support from French President Jacques Chirac and remains a candidate for future enlargement.

ECONOMY: Modest progress, but task is unfinished
For much of the 1990s, Romania attempted unsuccessfully to make the transition from a planned, to a market-based economy. Many prices, as well as the exchange rate, remained controlled and loss-making industries in need of overhaul were not restructured. The result was a mounting fiscal deficit and rising inflation. After the new President was elected in November 1996, the newly-installed government belatedly changed tack, committing itself in February 1997 to a shock therapy programme of reforms. Under the programme adopted, the exchange rate was liberalised, subsidies slashed, and directed credits phased out. This programme has hit Romania hard.

Romania still suffers from the after-effects of the end-1996 economic crisis, with inflation kept high by currency devaluation and administered price increases. The current account deficit is high, despite a weak economy and competitive exchange rate, but external debt is relatively low. Significant progress was made during 1997, however, toward placing the economy on a sounder footing. Romania maintains a restrictive monetary policy, which has kept inflation in check in recent months, though a 4% increase in VAT pushed monthly inflation up to 7.2% in February 1998, from 4.9% in January. Annualised inflation fell to 109.3% from 131.9%. The government has set an end-year target rate of 45%, but around 70% is more realistic. Nonetheless, that would compare favourably with annualised inflation of 151.4% in 1997. Fuelling inflation last year was the generous compensation extracted by laid-off miners when the government began shutting down loss-making mines. In March 1998, the government announced an 8.9% increase in prices for goods and services provided by state-run monopolies, including water, transport fares and medicines, effective from April 1, along with plans to raise energy prices and telephone tariffs.

The effect of the price increases will be to keep inflation high, putting the year-end inflation target out of reach. The method of adjusting prices is to change, with future adjustments to be lower than the general consumer price index. Varying levels of monthly indexation have been set for pensioners and the unemployed to compensate for price rises until end-1998. Romania has around six million pensioners - the average monthly pension is ROL300,000 (US$35). The national unemployment rate in March was 9.7%, with a rise to 11% seen by year-end. This year’s budget offers wage indexation up to only 60% of inflation. Union leaders earlier rejected the government’s wage target. Romania’s minimum monthly wage was raised by 40% to ROL350,000 from April 1, in response to the recent upturn in inflation, though that was still well below the ROL600,000 demanded by unions.

A recent report from the Paris-based Organisation for Economic Cooperation and Development (OECD) estimated that the Romanian economy contracted by 6.5% in 1997 (subsequent data measured the actual decline at 6.6%), though a return to positive growth of 1% is forecast by the OECD for this year, accelerating to 3% in 1999. The private sector bore the brunt of last year’s economic slump; investment by private firms fell by 50%, that of state-owned firms by 12%. A key factor behind the improved outlook has been stabilisation of the Leu, following introduction of convertibility in February, after last autumn’s currency plunge. But the Leu will soon come under renewed pressure unless inflation is reduced further. In March 1998, Romania announced its intention to notify the IMF that it accepts Article Eight of the Fund’s statutes on currency convertibility, whereby countries agree not to impose restrictions on payments and transfers for current account transactions, essentially foreign trade, and not to operate multiple currency regimes. Capital movements can still be restricted, however.

Under a US$410m standby accord with the IMF, Romania promised to liberalise foreign exchange markets and introduce full current account convertibility. Romania freed its foreign exchange markets in 1997 by lifting restrictions which allowed only four banks to act as market-makers on the local interbank market. In January 1998, the central bank (BNR) issued new currency regulations, under which Romania abandoned the US$500m annual limit imposed on Romanians’ hard currency purchases. Convertibility under Article Eight should reduce the risk of investing in, or lending to Romania.

Fiscal policy remains tight. After the excesses of earlier years, progress was made in cutting the general government deficit, to 4.6% of GDP, in 1997, and the pace of privatisations was stepped up for a time. The Finance Ministry plans to improve tax collection from bad debtors, particularly from those in the state sector. Overall debt arrears owed both to the budget and to suppliers by some 150 state firms are estimated at ROL27.0 trillion (USUS$3.4bn) at end-June 1997, with ROL8.0 trillion in overdue payments to the budget. The 14 regies autonomes - companies in sectors where the state has kept a monopoly since the Communist era – are responsible for around 70% of the total overdue amount owed to the budget. Their restructuring is a key demand under the stalled IMF loan accord. Renel (electricity authority) led a list of 10 state companies and regies autonomes which owe the greatest amounts to the budget and to their suppliers, along with other companies with large arrears, including Sidex (steel mill), Romgaz (gas authority), Petrom (national oil company), SNCFR (railway authority), Petromidia (oil refinery), RAH (coal utility), and Comtim (farm holding).

Agricultural reform: another casualty of government inertia

An important casualty of the slowdown in reforms is the farm sector. Agriculture should be driving the economy toward prosperity, but it will not be able to as long as it is hobbled by monopolies. Romania’s farms are too small to be economically viable, lacking the fertilisers and seed to grow high quality grain. Compounding its problems, the entire distribution system is effectively controlled by monopolies. While distribution could be liberalised, it requires political will that is lacking. Sorting out the sector’s problems would involve breaking up some monopolies, which stand to lose out if agricultural reform moves ahead quickly. Romania effectively has only one grain terminal to handle exports, creating serious bottlenecks and raising distribution costs. Inland storage is also a state monopoly.

An infusion of foreign money would go a long way to remedying the sector’s problems. North American grain traders such as Cargill and Continental Grain have been active in Romania for over a year, and both are looking to buy inland storage facilities but are unable to because none of the inland grain silos has been offered for privatisation. Romanian grain farms yield about 2.8 tonnes per hectare, compared to 8 tonnes in the West, while the low quality grain produced sells for little more than half the price of international quality grain. With 13 million hectares of arable land, refusal to pass basic agricultural reforms is costing Romania’s economy - and the 30% of the workforce employed on the land - almost US$9bn a year. Land reform remains stalled. Some 85% of agricultural land has been privatised, with state farms carved up into holdings averaging only five hectares, against the minimum viable farm size of 50-100 hectares. As no land reform bill has been approved, farmers cannot sell their land, forcing them to remain as peasant subsistence farmers or to lease their holdings for nominal rents to state farms or collectives.

While Ciorbea’s government, initially at least, was more committed than previous administrations to pursuing farm sector reform, its task was complicated by vested interests. A US$100m deal, involving North American companies such as Case and Valmont, for the supply of modern farm equipment, backed by US Eximbank financing, has been under negotiation since April 1997, but remains stalled. In the domestic farm equipment sector, the position is even worse, with Italian manufacturer Fiat New Holland forced out of a US$50m bid to acquire Semanatoarea, a Bucharest-based combine-harvester manufacturer, when the government called off the deal in the face of union opposition in late-1997.

Still the doubts remain
While the outlook has brightened with the political stalemate broken, the OECD’s recent assessment of Romania’s situation appears too optimistic. In late February 1998, US rating agency Moody’s Investors Service announced a downgrade from ‘positive’ to ‘stable’ in the outlook for Romania’s Ba3 foreign currency country ceiling for bonds, and the B1 ceiling for bank deposits. Moody’s noted that political difficulties have impeded rapid and smooth implementation of Romania’s reform and stabilisation programme, adding that the medium-term rating outlook depends on the pace of structural reform. Romania has a BB- rating from Standard & Poor’s (S&P) and Fitch IBCA, and a BB+ rating from Japan Credit Rating Agency. S&P, however, has placed Romania on watch for a downgrade.

 
Hopes pinned on budget passage, privatisations
On the microeconomic front, progress has been made but much remains to be done. Most prices have been freed, but inefficient monopolies are only in the initial stages of restructuring. Some of the largest bankrupt companies have been closed, though the government has been back-pedalling by agreeing to generous severance packages for employees. It is crucial that bankruptcy laws are strictly enforced. Inter-enterprise debt, particularly in the public sector, is accumulating. Most small and medium-sized enterprises have been privatised, but only a few of Romania’s largest companies have been sold off. Banks and telecommunication companies are due to be privatised soon, though their sale is running behind schedule, and it could be 1999 before other utilities are sold. Privatisation proceeds are estimated at around ROL7,815bn (of which 20% will remain at the SOF’s disposal), representing a significant amount of the 1998 budget.

The main challenge for the government is the passage of the 1998 budget in a form that satisfies IMF conditions. After spending two weeks in Bucharest, the IMF was unable to reach agreement on a programme for the year and departed in March without issuing the fourth of five tranches of Romania’s standby loan. Release of the tranche depends on the budget’s implementation. Almost immediately after the IMF’s departure, the government announced fiscal reforms in line with the Fund’s proposals. At the same time, the IMF tied future credits to commitment to faster privatisation, especially of the banking sector, and restructuring of loss-making industrial giants. Since Communism’s fall in 1989, Romania has also drawn some US$1.3bn from the World Bank in various project loans, to help reforms, including enterprise restructuring.

Even during the first-quarter 1998 political crisis, reform edged forward cautiously as investor-friendly privatisation and investment laws were passed. This was accompanied by relaxation of the foreign exchange regime. Russian oil giant Lukoil made a US$300m acquisition of a 51% stake in Petrotel, a Romanian oil refinery. In March 1998, Combined Energy Companies (CEC) of America signed a US$200m deal with ALRO, an aluminium producer, to build a power plant, in a deal that will be fully financed by CEC, without government guarantees.

A string of headline privatisations is scheduled for 1998, including national telecommunications monopoly Rom Telecom, the flagship of the privatisation programme, which could raise up to US$4bn. Romania’s Communications Ministry launched a tender in March 1998 to sell 35% of Rom Telecom to a strategic investor by July, advised by Goldman Sachs. Six telecoms companies have expressed interest in bidding for the stake, including France Telecom SA, Deutsche Telekom AG, Italian telecom group Stet Spa, Greek telephone company OTE-Hellenic Telecom SA, Southwestern Bell Communications Inc of the US, and Dutch postal and telecoms group Koninklijke PTT Nederland NV. Announcement of the winning tender in mid-1998 will be followed by the sale of a further 60% stake in Rom Telecom via a public offering by October. In January, Rom Telecom secured a US$100m loan from the EBRD, partly to finance an investment programme aimed at installing 500,000-600,000 telephone lines in 1998-99. It has three million subscribers and a 55,000-strong workforce. Its sell-off plans run parallel to a restructuring programme aimed at enhancing the company’s market value.

In addition, two small state-owned banks may be sold by end-year. Western investment banks have been mandated to prepare the sale of a number of other large enterprises, including auto manufacturer Dacia, Sidex, a steel producer that generates the largest share of the country’s foreign exchange earnings, and Tractorul, a tractor manufacturer. Romania’s SNCFR state railway is also to be restructured over a two-year period. Under the planned restructuring, the railway would be reorganised into a parent company, and operating units including infrastructure, passenger transport, freight, and rolling stock and storage. Its workforce would be cut to 70,000 from 135,000 currently. Similarly, oil refining needs to be overhauled. Most Romanian refineries are technically bankrupt, but are being kept afloat by Bancorex.

Foreign Investment: Waiting in the wings
Equity investors have become increasingly frustrated at the political stalemate delaying reforms. Having retreated to the sidelines in the second half of 1997, as privatisation slowed to a crawl, they stayed there during the recent impasse. Foreign portfolio investors are estimated to be holding US$475m for investment in Romanian stocks, which would inject new life into a market which resumed trading only recently. Much remains to be done on strengthening the institutional framework, and achieving macroeconomic balance, before foreign direct investment (FDI) and equity market flows will improve significantly. Cumulative FDI between 1989 and 1996 amounted to only US$1.2bn, or US$52 per capita.

On the plus side, the Romanian economy is large with a well-educated workforce and, starting from a low base with a high share of agricultural labour, has strong potential for catching up with its more advanced neighbours, Hungary and Poland. These factors should help underpin faster GDP expansion in the longer term, and, if improvements are made on the institutional side, future prospects for the local equities market should be good.

Budget blockage, policy paralysis
Economic prospects for 1998 hinge on the passage of the government’s austerity budget, which forms the focal point of Romania’s reform programme. Making the budget work will depend on far-reaching structural reforms, including privatisation, closure of loss-making enterprises, subsidy reductions and public sector lay-offs. All of these will be unwelcome among a population whose purchasing power fell by an inflation-adjusted 22% in 1997. IMF representatives have criticised the proposals as over-optimistic, arguing that inflation and privatisation revenue targets are unrealistic. Under the draft 1998 budget approved by the government in mid-March and submitted for Parliamentary approval five months later than required under Romanian law, the state budget deficit is set at ROL12.85 trillion, or 3.1% of GDP against 3.6% in 1997.

Prospects for Parliamentary approval are uncertain, however, with the Social Democrats hostile to some of the proposals. Vasile, however, is a wily politician, who may give Romania some respite. He may secure the budget’s passage, albeit without the extreme austerity demanded by the IMF. First, however, the budget must go before Parliamentary commissions ahead of a debate by a joint session of the government’s two chambers. A budget defeat in the assembly would not, however, amount to a confidence vote, but foreign investor confidence would take another hit. Compounding Romania’s difficulties, payments on the external debt will approach US$2bn in 1998. Add to that a current account deficit that is expected to exceed 4% of GDP, and Bucharest faces the prospect of a significant funding gap.

BANKING SECTOR
Romania’s banking sector comprises four big state-owned banks and a number of relatively small private banks, which together make up around one-quarter of the banking system’s total Leu deposits. Private banks account for an increasing share of capitalisation in the banking sector. Foreign banks are also building up their local presence. In early 1997, the banking system consisted of 39 licensed institutions, seven of which were state-owned, 23 had private or mixed (state and private) capital, while nine were branches or subsidiaries of foreign banks.

Romania’s main challenge is to restructure its state-owned banks, which have built up substantial doubtful loans to state-owned firms and agriculture. Restructuring measures have been initiated with the backing of international financial institutions. A bank privatisation law was submitted to Parliament in April 1997. Shares originally held by the Private Ownership Funds will be transferred to the SOF that is responsible for the banks’ sale. There is no limit on the shareholding that can be acquired by private domestic or foreign investors.

CONCLUSION
Aside from attractive opportunities for investors in existing Romanian equity and debt instruments, 1998 is likely to see a number of new offerings on the Bucharest market linked to privatisations, in particular Rom Telecom’s IPO, in which foreign investors have shown strong interest. In addition, planned sales of state-owned banks, auto manufacturers and utilities are slated for 1998-99. Substantial FDI is needed in agriculture and oil refining, sectors long overdue for restructuring and which have already caught the attention of American and Russian companies, seeking to exploit scope for efficiency gains and increased profitability.

We continue to believe that trade finance instruments represent the most interesting asset class, where such instruments bear the guarantee or aval of the strongest banks, amongst which we would group Bancorex, Banca Comerciala Romana, Banca Romana Pentru Dezvoltare, Banca Comerciala "Ion Tiriac" and Banca Agricola. Whilst economic and political problems continue to exist, and will take time to be resolved, we believe the critical and strategic requirement for the financing of trade flows to remain uninterrupted produces an attractive combination of risk and reward.