Romania rides the second wave

THE NEXT FEW months will provide key tests of the progress Romania has made in a long transition – from eastern Europe's most dysfunctional political economy in the 1980s, through a laggardly position in the regional reform process in the 1990s, to the prospect of acceding to the European Union in a few years' time.

In October, the European Commission, having long ago rejected Romania for entry in May this year, will decide whether or not to approve its application for accession in 2007.

The following month Romanians will go to the polls to elect a president and parliament. Then the government hopes to complete EU negotiations late this year – and sign an accession treaty in early 2005. If all goes according to plan, that is.

Continuity in the reform process suggests that most foreign investors favour the current centre left Social Democrat (PSD) government, under president Ion Iliescu and prime minister Adrian Nastase. But this matter is less of an issue than it might have been once because politics in Romania these days is relatively sedate. All parties – except the extremist PRM – are agreed on the need to join the EU, and as soon as possible.

Things did not look good earlier this year. The European Commission's DG Enlargement end of year 2003 report slammed Romania for failing to reform the judiciary and state-owned companies, lambasted the pervasiveness of corruption, and concluded baldly that Romania did not possess a "functioning free market economy" capable of competing in the EU.

It threatened to delink the accession progress of Romania and its better performing neighbour Bulgaria, raising the possibility that Romania would have to wait another year.

Such an idea was not worth contemplating in Bucharest.

Mugur Isarescu, governor of the National Bank of Romania, says: "The postponement of the accession date would have negative consequences not only in psychological but also in financial terms.

"First, it would reduce the speed of FDI. In the first five months of 2004, FDI increased by close to 39%, on the back of the country's joining Nato and of its becoming the next-wave EU candidate. Second, it would buy time for vested interest groups to delay inevitable reforms. Third, it would postpone membership of ERM2 and of the eurozone, which are, in themselves, important disciplining factors for all social groups. Last but not least, the negotiation power of a country is greater within the EU than outside it."

In the past few months, the government – stung into urgent action – has rammed home a series of reforms and privatizations designed to impress the European Commission and that other driver of change, the IMF.

At the end of July, the government agreed to sell off Petrom, the country's largest oil company, to Austria's öMV for about e1.5 billion – making it Austria's largest ever investment abroad.

Also in July, as the IMF swept into town and the European Commission gathered materials for its autumn verdict, the government finalized the sale of Electrica Banat and Electrica Dobrogea – two regional power distributors – to Enel of Italy. At the same time, progress was made in the sale of DistriGaz and other gas distributors.

A further gesture of intent came when the government revised down the deficit target from 3% of GDP to 2.1% when discussing next year's budget with the IMF.

Petrom deal marks a breakthrough

Petrom: completion of Romania's largest ever privatization, in the face of political resistance, shows the government's commitment to the EU

Although it has existed for more than 100 years, the Romanian oil market has increasingly suffered from refining overcapacity allied to lack of imported crude oil – concocting a classic mess of high operating costs and low efficiency.

As a result, the significance of Petrom's privatization contract extends well beyond the oil industry, states a report by the British Business Community in Romania. "Inflation, arrearage, foreign investment, as well as the budget and the trade deficit will all be influenced by the biggest privatization process ever concluded in Romania," it notes.

"There has been some very good progress in recent months that is quite remarkable in my view, especially taking into account that this year is an election year," says Elisabetta Falcetti, the economist covering Romania at the European Bank for Reconstruction and Development. "It is important to recognize that the government has made important steps: the Petrom privatization was done against some internal resistance, and committing to increase prices is an important achievement this year."

Also speaking of the Petrom deal, Patrick Gelin, chief executive officer at BRD-Groupe Société Générale in Bucharest, admits: "Frankly speaking, a few months ago, I wouldn't have bet on that being done this year." He adds: "The pressure of joining the EU has been very important psychologically, and is a major factor in the progression of the country."

Charles Robertson, head of eastern Europe economic research at ING in London, recalls conversations in Bucharest a couple of years ago: the prevailing wisdom then was that it was highly unlikely that Petrom would be privatized within five years – or, in one ultra-pessimistic forecast, even 10 years. "The centre-left PSD government has proven to be highly pragmatic," he says. "It has been internally cohesive – in stark contrast to the political volatility of the last centre-right coalition governments."

He continues: "It has been fortunate to inherit the growth benefits of strong reform efforts by those chaotic governments. But, in addition, it has continued with some privatizations, kept fiscal policy tight and been the first government to successfully complete an IMF deal [last October]."

The next two years are pretty much set in stone in terms of economic policies and legislative changes, says EBRD's Falcetti, because of the agreement with the IMF and, on the regulatory side, because of what was agreed during negotiations of the EU acquis. Even if there is a change of government, all parties are committed to Romania joining the EU.