Ilan Laufer, Romania’s business environment minister © Alan Knox/FT
Experimental feature

Listen to this article

00:00
00:00
Experimental feature
or

Ilan Laufer, Romania’s business environment minister, knows something about eye-popping transformations. In his spare time, the 33-year-old models for men’s fitness magazines that advise readers on how to make muscular gains in record time.

“There’s no such thing as bad publicity,” he smiles, pushing a protein shake flask to the side of his desk in the economy ministry, “and we’ve had quite a lot lately.”

Romania, perched on the EU’s eastern frontier, is drawing attention to its own extreme makeover. Economic output grew at the bloc’s fastest rate in the first quarter of 2017 (see chart below), while the view of cranes from Mr Laufer’s office underlines how Bucharest is modernising into a more westernised and prosperous city. Success brings increased demands from citizens for higher wages, better infrastructure and transparent government.

The country has been in the headlines for other reasons, too. An anti-corruption clampdown is troubling senior politicians in what President Klaus Iohannis calls the necessary but “ugly phase” of cleaning up the system. The tensions have led to frequent changes of government in the past two years.

Romania’s government, its third in less than a year, is scrambling to meet its ambitious promises on tax cuts, wage rises and investment without breaking an EU-mandated deficit limit, set at 3 per cent of GDP. Brussels expects that Romania will breach the limit this year and next. The country is also considering radical changes to the tax system.

Ministers say now is the time for higher wage rises and infrastructure spending, which will help the economy close the gap with others in central and eastern Europe. The country remains the second poorest in the EU and investment has yet to return to its pre-economic crisis peak of 2008.

“Infrastructure is the main thing holding back investment,” says Mr Laufer. “It’s our weakest point. That’s why we are doing everything to connect the country’s highways by 2020.” One such project is the completion within three years of a motorway connecting the Port of Constanta with the west of the country, so delivering on an earlier promise aimed at keeping big manufacturers like Renault in Romania.

Mihai Fifor, the economy minister (who became defence minister shortly after talking to the FT), says the plan is a responsible one: “We have always thought that fiscal relaxation combined with an ambitious investment programme can only lead to sustainable economic growth.”

Pumping up the economy while the public finances are strained, however, has proved difficult. There was a wobble in June when an unexpected pension reform, a corporate turnover tax and a higher band of income tax were announced and then quickly dropped after a business outcry and a sharp rise in bond yields.

Mihai Fifor, Economy Minister © Alan Knox/FT

The confusion drew a rebuke from President Iohannis, who appealed to the government to stop its “fiscal-budgetary hopping”.

Ionut Dumitru, chairman of Romania’s fiscal council, a budget watchdog, says government handling of the situation was chaotic. Its proposals “created a lot of noise on the markets”, only for the government to deny they were on the table. “It created a negative impression in investor minds,” Mr Dumitru adds.

Mr Laufer counters that the turnround indicates a responsiveness to business sentiment that investors should view positively. “We made a suggestion, the business community said it would not work and then we changed it. That’s democracy.”

Keeping its big spending promises while maintaining a predictable business environment will be the main problem for the government as a new legislative term gets under way. Prime minister Mihai Tudose this month hinted at fresh proposals on redirecting some mandatory private pension contributions to help meet official spending commitments. He wants to increase tax revenue by reducing tax minimisation by multinational companies and VAT fraud.

“If we want campaign promises to become reality,” Mr Tudose has said, “we must forget the state of normality.”

Ionut Dumitru, chairman of Romania’s fiscal council © Alan Knox/FT

Iancu Guda, president of the Association of Banking and Financial Analysts, believes the government needs to offer more long-term regulatory certainty: “It’s good if you see that a measure is damaging and then you drop it but it’s not encouraging to have many incidents like this,” he says. “It signals to investors there is a lack of strategy and predictability.”

Some of the proposed measures still on the table present difficulties. Small businesses will struggle with new minimum wage requirements, which outstrip productivity rises, and will force many to increase prices, according to Mr Guda’s analysis. Public sector salary rises are expected to increase inflation from just below 1 per cent to 3 per cent by the third quarter of 2018.

Combined with an ageing population — shared by all countries in the region and exacerbated by emigration — Mr Guda fears that Romania’s reputation for labour cost competitiveness may quickly be eroded. “Having fewer workers, with lower educational attainment but higher wages, and then adding fiscal uncertainty can produce an increased risk premium for companies,” he says.

Romania faces thorny problems with its anti-corruption clampdown, a wide-ranging legal offensive that touches nearly all political parties. An attempt by the centre-left government to curtail the process sparked big street demonstrations in February. Proposals for greater control over how prosecutors are appointed and judges supervised have prompted EU warnings.

Such measures could set back the anti-corruption fight by a decade, according to Mr Iohannis, and risk bringing about the kind of contentious efforts to curb the judiciary seen recently in Poland. The European Commission in August warned Bucharest that “the irreversibility of the progress achieved by Romania in the fight against corruption in the last 10 years is essential for the Commission”.

Analysts forecast further tensions in the coming months as high-profile anti-corruption prosecutions continue. Liviu Dragnea, the ruling party leader, has been charged with abusing public office. Mr Dragnea — who denies the allegations — is already prevented from becoming prime minister because of an earlier conviction. A second would mean a custodial prison sentence.

One seemingly unshakeable Romanian stance concerns the country’s strategic position as a Nato and EU member. That contrasts with more pro-Russian policies adopted by some of its neighbours such as Hungary, which has criticised EU sanctions against Moscow. Combined with sizeable Black Sea energy reserves, Romania’s approach makes it an important western ally in uncertain times.

“Look at what’s happening in Ukraine and the unpleasant effects of the events in Turkey last year,” notes Mr Laufer. “We are clearly the most pro-American and pro-EU country in the region.”

In July, Romania, which shares a maritime border with Russia across the Black Sea, played an important role in jointly hosting the largest US and Nato military exercises staged in eastern Europe. It is on course to reach its defence spending target of 2 per cent of GDP, thanks in part to a $3.9bn deal announced over the summer to buy Patriot missiles from the US.

While many Romanians may take pride in the country’s enhanced military strength, some chafe at its shortcomings. Defence minister Adrian Tutuianu resigned in early September after a budgetary shortfall led to army salary payments being postponed.

The soldiers will eventually be paid, no doubt, but critics view the debacle as a sign of something broader. The government has pledged to spread the benefits of Romania’s economic success but — by so doing — it has raised expectations it may be unable to fulfil.

Copyright The Financial Times Limited 2018. All rights reserved.