Inflation Surpassing Populism
In a Europe locked-in below-target inflation, for the most part, one country basically surpasses all others. Romania managed to almost triple its inflation rate one month into the New Year, after a brief – and unique period in the last quarter century or so – when the headline figure was actually negative. What’s behind this astonishing success, or not such a success after all?
Although badly hurt by the Great Recession, the country is not exactly a poster-child for anti-austerity economists to rejoice. In 2008, before the financial crisis was felt, the inflation rate was an uncomfortable 7,9% yoy. Enough to prevent a liquidity trap some would say. The headline figure then fell from 5,6% yoy in 2009 to 4% yoy in 2013. In 2014, following a reduction in the value added-tax for food and food-related services, the headline inflation figure slipped to 1,1% yoy, aided also by the fall in global commodity prices, oil in particular. The number slipped into negative territory in 2015 (- 0,6% yoy) and especially in 2016 (- 1,5% yoy), the year the value-added tax was again reduced, this time for all goods and services, only to rebound in 2017 to a significant, but modest 1,3%. Now, for 2018, Romania’s central bank, BNR, projects a headline inflation rate of 3,6% yoy, that is 10 basis points above the upper-bound of its 2,5%, rather elusive, inflation target.
The recovery in the Romanian economy isn’t phony. The standard unemployment rate was down to a low of 4,6% in December 2017, from a peak of 7,5% in March 2012. Business and in particular household indebtedness in foreign currency, which limited monetary options when the financial crisis struck, has been reduced. The banking system has sold at a discount a few billions of euros worth of non-performing loans. Although several more are still to be extinguished from the books, the non-performing rate has dropped in the closing months of last year below the 8% threshold BNR considers dangerous and is set to reach 6% this year. Even the budget deficit was kept within the 3% EU agreed bound, and the Government refinanced and extend the maturity of its external debt at record-low interest rates and risk premia. The quarterly GDP growth rate for the last three months of 2017 ominously surpassed the 8,5% 2008 annual growth rate. But the recovery alone doesn’t explain the sudden New Year tripling of the inflation rate.
Energy, fuel and food-stuffs are responsible for all of the increase in the CPI. Highly regulated utilities prices (electricity, heating gas, water, etc.) have been increased a few months earlier than scheduled. Oil prices have began to rise worldwide, but the Romanian Government also reintroduced an excise tax at gas stations. Finally, food prices began to rise in the last months of 2017 on expectations of wage and pension increases – the Achilles’s heel of the current Romanian Government economic policy.
If the populist backlash against sound economics continues, the Romanian economy will again be trapped in the wage-price spiral that the advanced economies surmounted since the 1980s.
Since taking power in 2012, the ruling Social-Democratic Party has boasted about increasing wages, a sensitive and votes-winning topic in a country which is still in the bottom EU median wage-earnings ranking, all the more after a resented 2010 cut in public wages. However, the idea could not be put into practice as long as the country was closely scrutinized by its official emergency creditors in the aftermath of the 2009 recession and balance of payments crisis. Now that most of the official debt contracted has been repaid, the Government has a freer hand and everything it says on the topic will rapidly feed poorly anchored inflation expectations.
We thus get to the moral of our story. In reality, wage growth has been below what the Government promised. It started, in a truly remarkable love of the people-fashion, with an almost tripling of the pay of the politicians themselves and fellow high-level bureaucrats, some two years ago. The social-security and health-care contribution reform basically left the net-disposable income of most wage earners unchanged (and the budget deficit in target!), but not the expectations of the very important public-employees constituency, especially the less fortunate not in the law, order and defence category. The pensioners, a most favourite Social-Democratic constituency, did get an increase, both because of an average 10% increase in pensions and because of a 6% reduction in personal income tax designed to absorb the income loss of active workers as a result of the transfer of social and healthcare taxes from the employer to the employee. However, the biggest winners so far have been the minimum-wage earners, who saw a 24% increase in earnings at the beginning of the year amid a tightening labour market, long-term job market distortion notwithstanding.
A year ahead from now, PSD – the ruling Social Democratic Party, currently busy dismissing and changing its own heads of Government, for a third time in a year, to suite the wimps of its powerful chairman Liviu Dragnea – will be in full battle to win the presidency, something this party hasn’t manage to win since it was last held by Ion Iliescu, its honorary president and re-inventor of the office after the fall of Communist leader Nicolae Ceauşescu, more than a decade and a half ago. Even more importantly, for a party of the republic often torn inside between presidentialism and parliamentarianism, the year after the next year legislative elections will be held. In these circumstances, it is doubtful that the PSD Government will show the restraint it has shown so far, because buying votes and bribing constituencies at the expense of macroeconomic stability is a well-established practice in Romania even among Liberal and right-wing parties.
Populist talk and ostensive lack of appetite, even hostility, for market reforms and policies are already in part responsible for the over-the New Year tripling of the Romanian inflation rate. Most of the increased public spending on pensions, public wages and welfare is done at the expense of investment in badly needed infrastructure and modern public services to support growth. This consumption spree fuels the current account deficit, putting pressure on the exchange rate and adding to the inflationary pressure. Productivity growth is lagging, because many state firms in need of reform are nowadays being reverted to the old-style political clientele accessories and budget holes. There’s a real impetus in the current PSD Government towards dismantling transparency and reporting rules for public companies or even renationalising previously privatised companies for no good reason. The main lesson the Romanian Social-Democrat leaders – but also other populist politicians in Eastern Europe and in Europe in general – apparently learnt from China’s economic success in the last decades was not that competition, markets, entrepreneurship, trade and foreign investment help build a modern, prosperous, technologically advanced, economy, but that financially undisciplined and crony state companies do.
In the end, if the populist backlash against sound economics – not to mention sound institutions and legal environment – continues, the entire Romanian economy will again and very soon be trapped in the wage-price spiral that the advanced economies surmounted since the 1980s and the Romanian authorities tried for a decade to tame without apparently quite yet mastering a way out. On the 8th of January, BNR began raising interest rates, with a modest increase from 1,75% to 2% of its policy rate in a rather rare show of independence. But a new BNR inflation forecast in January 2018 now projects an even higher annual inflation rate of 4,475%, which should only come down within the target’s 1% upper bound in 2019, prompting its governing board to raise the interest rate, already the highest in the region, a further 0,25% in its 8th of February meeting. This independence will be further tested in the years to come, as Government policy becomes more erratic and interest rates rise globally. For now however, after three years of below-target, even negative, headline inflation rate, the Bank – which was never a hawkish anti-inflation institution – will probably err a bit in the other direction.