beyondbrics

As well-read Romanians know, when sorrows come, they come not single spies, but in battalions. A miserable few weeks for the country looks set to get even worse: today finance minister Sebastian Vladescu warned that the economy would probably contract by more than 1.5 per cent this year.

The downbeat outlook, reported by newspaper Ziarul Financiar, reflects Bucharest’s decision to raise value-added tax in order to keep within a 6.8 per cent budget deficit target agreed with the International Monetary Fund.

As western Europe basks in a heatwave, the country is mopping up after severe flooding that has left more 20 people dead and caused millions of euros of damage. And even when the flood waters recede, it is dawning on Romanians and international investors alike, that things will not improve in a hurry.

For one, the government may be understating the problem. Analysts at Unicredit warned last week that the Romanian economy may contract as much as 2.5 per cent this year, following a 7 per cent contraction in 2009. Meanwhile, as a result of the five percentage point sales tax hike (taking it to 24%), inflation is expected to rise from a modest 4.4 per cent to around 8 per cent by the year end, reducing the scope for further monetary easing.

On top of all this, Romanian has a government that is at best dysfunctional, and at worst incompetent. Traian Basescu, the country’s bull-in-a-chinashop president, spoke out again this weekend against his government’s decision to raise VAT, proposing a taxation of pensions instead.

But to recap, the government hurriedly proposed the VAT increase after the constitutional court last month threw out its decision to cut pensions by 15 per cent. After allowing the public sector to swell out of all proportion during years of bumper economic growth, ministers’ belated realisation that they must take decisive action made a bad situation even worse.

Cutting a bloated public sector wage bill by 25 per cent and eradicating around one in seven civil servant jobs at a time of severe economic hardship could herald a winter of discontent in Romania. No surprise then that the leu dropped as much as 0.3 per cent on Tuesday, weakening for a third-successive day.

VAT hikes and public sector job losses send European economy into prolonged recession: the rest of the continent must surely be watching.