Romania: Capital Inflows Buoyant As Eu Lowers Obstacles to 2007 Accession, but Limited Scope for Fiscal or Monetary Tightening Maintains Risk of Inflation Overshoot

Summary

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A positive first draft of the EU enlargement commission's report on Romania and Bulgaria indicates that accession at the start of 2007 is still possible, but warns that 'safeguard' restrictions could be included in the first year's entry terms even if they are not used to defer the whole process by a year. Even if the positive tone carries over to the EU's final recommendation in mid-May, it is not certain that member states will refrain from invoking the safeguard clauses in June or that the applicants will accept early entry with reservations. Although its recent judicial reforms may have tipped the balance towards on-time accession, Romania must still prove it can implement the new laws and administer larger structural transfers adequately, and that it is tackling current macroeconomic imbalances. Rising private capital inflow is helping to maintain rapid growth by financing a substantially increased external deficit and is a positive sign that financial markets expect accession to be followed by continued monetary convergence with the EU. But the immediate effect is an appreciating RON that limits the central bank's ability to rescue its inflation target with further monetary tightening, increasing the urgency for the ruling coalition to plug its fiscal gap. This is likely to require a rise in indirect taxation in 2007, despite its initial effect of worsening headline inflation, given the commitment to keeping down the flat-rate income tax.

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Romania: Capital Inflows Buoyant As Eu Lowers Obstacles to 2007 Accession, but Limited Scope for Fiscal or Monetary Tightening Maintains Risk of Inflation Overshoot

EC moves closer to calling for on-time accession, but with restrictions

The preliminary accession opinion issued yesterday by EU enlargement commissioner Olli Rehn will be taken as strong endorsement by Prime Minister Calin Tariceanu's government, which will interpret it as a green light for accession on the scheduled date of 1 January next year. The National Liberal/Democratic Party (PNL-PD) coalition has consistently argued that Romania will have met its accession criteria by end-year and that economic and social progress will be set back if accession is delayed. Rehn will...

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