The financial situation of the Romanian government was released today. The main news is that the eight-month budget deficit widened to 12.97 billion lei from 11.36 billion lei at the end of July. Or in percentage the January-August budget deficit was equal to 2.39 percent of gross domestic product. The statement in Romanian goes on to say that this performance makes the forecast of the 4.4% deficit for 2011 achievable. As the statement does not show the amount of arrears I take their optimism with a little grain of salt.
Furthermore, the developments of the Romanian finances in recent years challenge the never ending optimism of the local officials. I understand that they have an image to uphold but the cost of Romanian firms and household not preparing for tough times can be devastating for the whole economy.
I will use two charts to put the press release from yesterday into perspective.
In the first one I show the dynamic of revenues and expenditures as percentage of GDP. Note that revenues seem to be capped at 34% of GDP irrespective of good or bad times. Of course there is no upside limit to expenditures. What we should expect for 2011 to achieve the government’s plans, the yellow part, is a decrease in expenditures as percentage of GDP from 40.8% to 36.9%. Very ambitious in my view and impossible to achieve. Also, as important is the drop in revenues from 34.3% to 32.5% although the Romanian government is expecting GDP to grow by 1.5% this year. Why are revenues falling while GDP is expected to increase? Actually both revenues and expenditures are expected to reverse to the 2007 level. Remember this is in percentage of GDP.
If GDP would increase by 1.5% this year, as it is foretasted by the Government and the analysts, then we will be back with nominal GDP at constant prices at the level of 2007. Something is very strange in this strategy. The expectations of both revenues and expenditures to fall while GDP is increasing seems out of place, especially the revenues part. Nevertheless, that is the government’s assumption.
But what if GDP this year does not show any growth or worse it shows a decrease relative to 2010? The graph below does not give indications of this happening. However, the current economic environment brings plenty of support to such a scenario. The bad part is that last time around the GDP fell from its peak in 2008 to a level below the one of 2007 but still close to. In the same time revenues remained almost constant in 2009 relative to 2008 and actually increased in 2010. Now, if GDP were to fall relative to 2010 it falls from a lower lever than in 2008 shrinking the economy towards the 2006 level.
To me the scenario expected by the government with a deficit of 4.4% for 2011 has almost zero probability of happening. I expect the spillover from global economy to affect revenues very fast in the next few months and the effort of reducing expenditures to be too costly especially in crisis time. GDP did not recuperate enough in 2010 and first half of this year to support the shock coming our way from the West. As the economy is driven by industry and agriculture (very rigid sectors compared to services) it will respond immediately to a negative global shock by contracting. Similar to what we saw in 2008 and 2009. Under current circumstances a more plausible scenario is one with deficit closer to 6%, on cash basis, for 2011. It is important to start planing to finance such a deficit as financing will only get more expensive as we get closer to the end of the year and further into 2012.
It is clear to me that the Romanian Government needs to find a solution to keep the economy growing. I know that Mr. Boc said he does not need a Nobel Prize winning economist to show him how to do it. He might be right. But with or without the help of other economist the current administrations needs to focus on growth. Until economics is re-written cutting taxes and showing a credible government expenditure cuts plan has worked very well to support growth. And to understand this you do not need a Nobel Prize or even a degree in economics. Even a political scientist can understand it.