“We work the same hours as in France, but we’re paid peanuts,” a worker at Renault’s Dacia plant in Romania said in April.
The factory, on the outskirts of the capital, Bucharest, makes low-cost Logan cars. Last month, thousands of strikers across the country staged a three-week “fight for wages like in France”, demanding a 70% salary boost. The Dacia demonstration was followed by truck driver and police rallies as well as a strike at Romania’s Indian-owned ArcelorMittal steel mill, where a third of the workforce demanded better pay.
Meanwhile, in Bulgaria, 2,700 striking workers at Czech electricity distribution firm CEZ were rewarded with a 25% pay increase, riding a populist wave of higher wage demands from public and private workers in the region.
Romania and Bulgaria are on their way to an economic transformation, with steadily falling unemployment and sustained economic growth at 6.0% and 6.2% in 2007, respectively. But poverty, inflation and awareness of wide wealth disparities with their EU counterparts are spurring demands for higher pay. Fractious coalitions in both countries are caving in to populist demands ahead of parliamentary elections.
Romania’s government spent 20% of its budget on public-sector wages this year, while private-sector pay demands are heating up in Bulgaria. The trouble is “higher wages can undermine competitiveness and fuel inflation if there are little productivity gains,” says Florin Citu, chief economist at ING Bank in Bucharest.
Danger signals
A rush of demand for consumer and capital goods has swollen current account deficits to hazardous levels. In Bulgaria its deficit leapt from 6.6% in 2004 to 23.8% in 2007. In Romania the jump was from 6.6% to 14% over the same period.
In Bulgaria, attempts to cool private-sector credit expansion have had little success. Last September, the central bank raised the minimum reserve requirement from 8% to 12%. But banks simply swallowed additional funds from abroad with a year-on-year increase in credit to non-government borrowers, rising to 61% in November after jumping to 54% in August from 25% in December 2006.
Moreover, a pro-cyclical policy mix over the last two years has left Romania exposed to global market forces. The government cheerfully loosened fiscal policy at the end of 2006 with the 12-month rolling budget deficit widening markedly from 0.3% of GDP in November 2006 to 2.6% of GDP in mid-2007.
Driven by the strengthening of the leu and low inflation, the National Bank of Romania (NBR) slashed interest rates by 175bp to 7.0% in the first half of 2007, causing the current account deficit to swell. Private-sector credit spread by foreign-owned banks increased by 63% in 2007, fuelled by loose monetary policy in the aftermath of full-blown EU membership in January 2007.
Euro troubles
The trouble is that the policy tools to temper domestic demand, cool external borrowing and put Bulgaria and Romania onto a sustainable macroeconomic path are limited.
Bulgaria operates a currency board against the euro. This means that it has effectively transferred its monetary policy to the European Central Bank (ECB). In both countries, an open capital account and a high proportion of foreign currency lending in the financial sector means monetary policy cannot control domestic demand.
Credit agencies fear these countries could be exposed to an external financing shock as risk-averse investors take flight. In Romania, the currency has fallen by around 19.5% against the euro in nominal terms since mid-July last year. And Bulgaria’s equity market has fallen 30% since the start of 2007.
At the end of January, Fitch revised Romania and Bulgaria’s outlook from stable to negative. “External deficits that were easy to fund in times of abundant liquidity and risk appetite may be harder to finance following the global credit shock,” said Edward Parker, head of emerging Europe sovereigns at Fitch at the time. “The negative outlooks reflect the heightened downside risk of an abrupt slowdown in capital inflows and a costly macroeconomic adjustment.”
Bucking a trend
Meanwhile, Standard & Poor’s has ranked Romania as third and Bulgaria as eighth most at risk, in this April’s Liquidity Vulnerability Index report.
Daniel Daianu, economics professor in Bucharest and former finance minister for Romania, is, however, bullish. “There is a mass of difference between Romania and other so-called vulnerable economies,” he says. “The latter have a high level of public indebtedness with short-term liabilities. So to draw the conclusion that disaster is around the corner because of Romania’s current account problem is wrong.”
Dimitar Kostov, deputy governor of the Bulgarian National Bank and formerly the country’s finance minister, is confident the near-term risks are contained. He argues the country’s deficit is financed largely by foreign investment, avoiding a heavy build-up of private-sector external debt.
“Bulgaria’s deficit is practically fully financed by FDI [foreign direct investment] over the past five to six years. By taking into account the role of the investment activities on the import, it can be said that the current account deficit is not just financed, but also driven by the inflow of FDI. The role of banks in intermediating foreign capital inflow is limited to one third of the non-FDI inflows,” he tells Emerging Markets.
Meanwhile in Romania, “there has been a substantial worsening of the structural composition of financing of the current account deficit; FDI is now less than 45%,” says Daianu.
In the past two years, Romania has been hounded by the threat of excessive hot money inflows, but the near-term monetary challenge is inflation. To stabilize prices and prop up the weakening currency, the NBR has hiked the policy rate by 200bp to 9% since October. However, inflation stood at 8% this February compared to a low of 3.7% in March 2007.
“Sustainable disinflation calls for a more rational mix of monetary, fiscal and wage policies,” says Berna Bayazitoglu, head of EMEA research at Credit Suisse. “A more consistent policy mix is needed to attain the inflation objective of 2.8–4.8% for end-2008 and 2.5–4.5% for end-2009 without posing risks to financial stability through a sole reliance on interest rate increases.”