WIIW The Vienna Institute for International Economic Studies - Wiener Institut für Internationale Wirtschaftsvergleiche

By Gabor Hunya

Good economic performance notwithstanding, Romania fell into the second government crisis within a year when Prime Minister Mihai Tudose resigned on 15 January. He had been in office since June 2017 when his predecessor Sorin Grindeanu was removed after just six months in office by his Social Democrat party boss Liviu Dragnea.

Political instability in Romania is at first glance quite surprising. Economically, the country is booming; with estimated full-year real GDP growth of 6.5%, Romania was one of the fastest growing economies in the EU in 2017. Meanwhile the ruling coalition of the Social Democratic Party (PSD) and the Alliance of Liberals and Democrats (ALDE) enjoys a comfortable majority in both houses of Parliament based on the election results of December 2016.

The reasons for the instability lie within PSD. Party chief Liviu Dragnea is able to keep all interest groups in the party under control, but cannot take the prime minister’s office because of a fraud conviction. Nevertheless, he wants to be in charge of government policies and nominates a prime minister and government dependent on him. When the head of government wants to govern based on own ideas or change his team, he is dropped by Mr Dragnea. This has now happened twice within a year.

Reforms required

Inefficient governance and pending judicial reforms are the two major problems for the administration, and will need to be solved if political stability is to be restored. The weakness of the government can be seen in the dire conditions in education and healthcare, delays in public investments and a low absorption rate of EU funds. The organisation, motivation and competences of the government need to be better defined, but such changes would go against vested interests. While the majority of the population is enjoying the benefits of the economic boom, there is a young urban segment which has repeatedly demonstrated against the government on political grounds.

As to reforms in the judiciary, PSD wants to achieve three aims with partly dubious content. The status of magistrates and prosecutors need to be clarified based on a Constitutional Court decision; the fight against corruption must become more transparent and not target only PSD politicians; and last but not least, Mr Dragnea wants smaller offences (including fraud) to be pardoned (which would allow him to become prime minister).

The government is in confrontation with President Klaus Iohannis on most of these issues. The president comes from the parliamentary opposition and is in charge of the powerful secret service (SRI) and supported by a number of European governments and the US administration. He is also a major supporter of the current activity of the National Anti-Corruption Directorate (DNA).

Who fights for rule of law?

Demonstrations across the country changed the course of a judiciary reform launched in February 2017. People protested against emergency ordinances changing the Criminal Code and trying to decriminalise anti-corruption offences (which would have enabled Mr Dragnea to take a government office). In the face of the protests, Prime Minister Grindeanu withdrew the related ordinances.

The government approved a fresh and modified set of judicial reforms in December 2017. This time it went through the normal parliamentary procedure and the Venice Convention has been asked to ‘approve’. The intensity of demonstrations was smaller this time. The new laws are in line with the demands of the Constitutional Court and clarify the status of courts and prosecutors. However, critics say that they also curb the power of the DNA and set back the fight against corruption. The US and several EU governments have expressed such concerns.

Concerns related to the latest judicial reforms are one-sided, however. The way the DNA is investigating corruption cases (based on the files of the SRI and presenting them in the media) infringes the right of defendants for free and fair court procedure. A clearer definition of offences and competences are necessary to put the fight against corruption on more solid legal basis.

Negative impact on the economy

Much of the current strong growth in Romania is being generated by loose fiscal policy, with the government implementing tax cuts and wage hikes in the public sector. So far, the resulting deterioration in external and internal imbalances have not put stability in danger. There has not yet been any visible impact on sentiment among foreign direct investors, presumably because business conditions are relatively good. Romania ranks 45^th on the World Bank’s Ease of Doing Business, just ahead of Italy and Hungary. In addition, the European growth cycle is generating demand for Romanian exports.

However, there are signs that this could change. Investors and business appear to see the potential for elevated political risk and government instability leading to economic destabilisation. Ten-year government bond yields rose from 3.8% on average in the first half of 2017 to 4.4% in the last quarter of the year and January 2018. (In comparison, Hungarian bonds were traded at 3.5% in the first quarter of 2017 falling to 2% in January 2018.)

Moreover, in 2018 Romania is facing weakening external balances, increasing inflation, a devaluation of the domestic currency and a fiscal deficit above 3% of GDP. Economic growth will decelerate to below 5%, while government expenditures are set to keep rising (the new wiiw forecast will be out on March 13.) An excessive deficit procedure may be imposed by the European Commission, triggering adjustments in the second half of the year. The National Bank will need to apply a more restrictive policy stance to keep inflation in the target band.

A stable government is desirable for managing the current strains in the economy, reviving public investments and putting EU funds to use. The current segmentation of political power is unlikely to allow such a government to emerge. The appointed Prime Minister, Viorica Dancila (Photo), a member of the European Parliament and chairperson of PSD women organisation, may not be the proper person, although she may improve the country’s image among EU decision-makers.