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DJ FOCUS: Romania's Slowing Economy Is Veering Off Track


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Romania's economy slowed markedly in the second quarter despite hefty private spending, heightening concern about the country's ballooning external debt.

Romania's gross domestic product expanded 5.6% in the second quarter, sharply down from the 7.4% pace posted in the same period a year earlier, and close to the rate achieved in 2005, when the country was wracked by devastating floods.

Most economists had anticipated an acceleration from the 6.0% growth of the first three months of the year. Now they must pencil in the effects of higher food prices and lower farm output, both large components of the economy.

The Romanian Statistics Institute will provide details on Friday, but recent wage and retail data suggest perilous imbalances are growing in the new European Union member.

The risk is that Romania, after six years of deficit reduction and fiscal reform ahead of joining the E.U., is undergoing "reform fatigue," said Ciprian Dascalu, senior economist for ING in Bucharest.

He worried that "policy complacency" would send Romania along the boom-and-bust path trod by Hungary, where years of lax fiscal policy sparked runaway inflation and debt levels. Current austerity measures will probably keep that economy from operating in high gear through 2009, according to Nordea analyst Anders Svendsen.

Hence Dascalu's fears. "We are concerned that what we are experiencing now may be as good as it gets for the Romanian economy for some time," said the ING economist, who had expected growth of 7.1% in the second quarter.

Romania's main stock market index declined 0.8% on Tuesday, its fifth consecutive daily drop, and is now down 11% from its July 24 high.

Drought around the Black Sea region has hurt more than half of Romania's arable farmland. That could knock as much as one percentage point off Romania's GDP this year, Ion Ghizdeanu, president of the national CNP forecasting commission, warned over the summer.

Achieving the CNP's forecast for 6.5% growth this year would require a substantial acceleration, even as the bulk of the damage to the agricultural sector - which accounts for 10% of GDP and a third of the work force - materializes during the autumn forecast.

Romania has a strong fiscal position, with its budget deficit totaling only 0.2% of GDP in the first half of the year. However, the government already has plans to push the deficit to 2.7% of GDP, with much of the widening due to hefty hikes to pension benefits.

Euphoria at joining the E.U. this year appear to have translated quickly into stalled structural reforms and a consumer binge.

That's evident in surging retail sales, which rose 23% in July from the same month a year earlier, the statistics institute reported Monday. That effectively matches a 24% annual jump in net wages during the same month.

Those wage gains, driven by concessions to public-sector unions and by labor shortages in the booming construction sector, more than offset productivity gains achieved as foreign firms enter Romania's manufacturing, retail and banking sectors.

"Higher wages are likely to lead to an acceleration of the trade gap widening," said Nora Rusu, an economist for ING in Bucharest.

The consumption binge - led by food and drink sales - is also outpacing capital investment, which promises future yields. Fixed investments rose 18.4% on the year in the second quarter.

That compares poorly with neighboring Slovakia, another new E.U. member whose GDP grew at an annual rate of 9.4% in the second quarter, the statistics office there reported Tuesday.

Consumer spending is accelerating in Slovakia, too - up 7.3% on the year - but that's only a fifth above the 6.3% growth of fixed investment. Moreover, Slovakia is harvesting past investments, as exports rose 18% on the year and imports only 14%.

As a result, Slovakia's current account deficit - a measure of reliance on external financing and also a proxy for vulnerability to any global credit crunch - is about 5.4% of GDP, down from almost 9% in 2006.

In Romania, by contrast, exports rose 9.2% on the year in June when measured in euros, while imports rose 22.2%. Romania's current account deficit hit 10.3% of GDP last year and looks likely to exceed the CNP's 2007 forecast of 11.5% - or EUR13.35 billion - by the end of the year.

There are "important and divergent trends between countries," said Neal Shearing, an emerging-market analyst for Capital Economics.

That's evident even in the employment picture.

The Romanian labor force is migrating to the public sector, an "unusual situation" for a fast-growing economy reaping a bonanza in foreign direct investment, said ING's Rusu.

With labor costs still only half of those in Slovakia, there's still time for Romania to correct its course and focus on productivity gains rather than temporary boosts to household incomes, said Dascalu.

"It all depends on policy makers," he said. "So far, their decisions are pointing to a populist path."





Copyright © 2007 Dow Jones & Company, Inc.

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