THE GLASS HALF EMPTY: INTERNATIONAL MONETARY FUND

UNCLAS SECTION 01 OF 02 BUCHAREST 000189

SIPDIS

STATE FOR EUR/NCE - WSILKWORTH, EB/IFD
STATE PASS USTR - LISA ERRION
TREASURY FOR STUART
USDOC FOR 4232/ITA/MAC/EUR/OEERIS/CEEB/BURGESS/KIMBALL
STATE PASS USAID

E.O. 12958: N/A
TAGS: ECON ETRD EIND EFIN PGOV RO
SUBJECT: THE GLASS HALF EMPTY: INTERNATIONAL MONETARY FUND
PERSPECTIVES ON THE NEW ROMANIAN GOVERNMENT

Ref: A) 04 BUCHAREST 03446, B) BUCHAREST 00130

THIS CABLE IS SENSITIVE BUT UNCLASSIFIED. NOT FOR INTERNET
DISTRIBUTION.


1. (SBU) Summary: The International Monetary Fund's (IMF)
representative in Romania is pessimistic about the country's
short-term future prospects for macroeconomic stability and
progress on economic reforms. The new government, in his
view, is inexperienced and will lose valuable time
understanding the levers of power, thus perhaps squandering
some of the positive gains from last year. Post sees this
negative assessment as bleak, although it agrees that the
new government faces macroeconomic challenges and a
challenging introduction to power. End Summary.


2. (SBU) Econoffs met on January 12 with Graeme Justice,
IMF's Resident Representative, regarding his perspectives on
the new Romanian government's (GOR) economic policies and
prospects. Justice began by emphasizing the inexperience of
the new cabinet and expressed doubt whether they have the
ability and understanding to make necessary reforms. The
previous administration required a six-month learning curve
before substantive discussions were possible according to
Justice, who noted that a longer time period will likely be
required for the new team. All ministers and most state
secretaries have been eliminated and the loss of

SIPDIS
institutional knowledge will be a burden this year. He
noted that mistakes have already been made during the
administrations first twenty days, including firings of
critical ministerial staff members and retention of weak
players. He fears that the GOR's honeymoon period will soon
end and scrutiny on its actions by the press will be
relentless.

LATEST FISCAL MOVES COMPOUND WOES FROM INHERITED BILLS
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3. (SBU) Justice's main concerns centered on the convergence
of election-driven salary and pension increases that the
previous government pushed through last year and the new
government's financial promises, including the new flat tax
of 16 percent (Ref B).


4. (SBU) Regarding the flat tax, Justice discussed the
recent case of Slovakia, which implemented a similar flat
tax rate as an incentive for tax evaders to join the
legitimate economy. Justice claimed that the Slovak flat
tax, structurally similar to the Romanian one, resulted in
lower government revenues and little shift of the gray
economy to the normal, tax-paying economy. Justice agreed
that enforcement of tax collection is key for the Romanian
government to meet its promises, but did not seem optimistic
about this prospect.


5. (SBU) Justice predicted that the government will, in the
months ahead, have to begin making tough, unpopular
decisions, including repealing the increases of government
salaries, as the government realizes that its budget is
unrealistic and the deficit widens. Justice returned to the
subject of Romania's unworkable budget several times,
emphasizing that expenditures will far exceed revenue.


6. (U) Justice also expressed concern about capital account
liberalization. He worries that once the government lifts
restrictions on foreigners who wish to invest in Romanian
lei (ROL) bank accounts, an influx of speculative investment
will occur (Ref A). When asked why Romanians feel pressure
to liberalize the account at this time, Justice stated that
account liberalization is viewed as an indication of a
developed economy, and Romania wants to portray itself as up
to Western economic standards.


7. (SBU) Justice mentioned that the International Monetary
Fund plans to send a group to Bucharest at the end of
January and that they intend to meet with the
administration. Although the group intends to give Basescu
encouragement as he faces difficult economic restructuring
ahead, Justice is already pondering how to break the news in
February that the budget is in bad shape.

COMMENT: THE GLASS IS HALF FULL
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8. (SBU) Post agrees with the IMF representative's
observations about the GOR's need to balance bold fiscal
policy with continued attention to macroeconomic stability.
The new GOR government will, indeed, soon face hard
decisions about laying off workers in the loss-making mining
sector as well as finding sources of funds to offset the
(presumably temporary) dip in government revenue due to the
flat tax's introduction.

9. (SBU) Post, however, assesses that Romania's economy
continues to be in a growth mode and revenues to the state
coffers should also increase, helping to make the flat tax
revenue dip less severe. Aggressive action against
prominent tax cheats has already occurred and additional
steps in this direction in coming months should encourage
more companies and individuals to pay their lawful share of
taxes. Finally, the local currency's (leu) increasing
strength on the foreign exchange markets at this time will
make imports cheaper and, at least in the short term, help
alleviate the danger of increased inflation.

DELARE