Painful cost cuts and tax rises have eroded support for Prime Minister Emil Boc's centrist coalition. His opponents want tax cuts and could even topple the eight-month-old government.
Whether Boc's government survives or not, a divided parliament is likely to prevent much-needed reforms and leave Romania struggling to meet its commitments under a 20 billion euro bailout deal led by the IMF.
Coming on top of opposition elsewhere in eastern Europe to IMF-mandated reforms, the situation will keep investors on edge through the coming months.
“A new season of political battles starts. We will see more blood than ever,” independent political analyst Cristian Patrasconiu said. “The main risk is that balance of power may dramatically change.”
The government has pushed through unpopular measures including public wage cuts of 25 percent, axeing thousands of state jobs and hiking value added tax by five percentage points.
Support for Boc's Democrat-Liberals has plummeted to record lows at about 13 percent. A nationwide survey by pollster INSOMAR in late July showed 51 percent of respondents in the European Union's second poorest member want a new government.
Elections are only due in late 2012, however, and it seems unlikely the opposition Social Democrats (PSD) – who claim to have gathered one million signatures nationwide against the government – would want to force an early vote or put together another complicated coalition at such difficult times.
“A no-confidence motion satisfies all parties. It will not pass,” said Guy Burrow at consultancy Candole in Bucharest.
“But the opposition shows it tried and the government has another opportunity to emphasise some of the difficult things it is doing,” Burrow said. “No other party wants power quite yet.”
IMF rescue, leu at risk
The economy contracted by more than seven percent last year and should shrink again after the VAT hike, leaving once-booming Romania with one of the slowest recoveries in eastern Europe.
Boc's first big test is in early September with a final vote on the VAT hike to one of the highest rates in the Europe.
Analysts predict a tight vote, as some of Boc's allies have rebelled against his policies and could again team up with the opposition, which is only 19 short of a majority.
Discontent in government ranks has reached such a point that some may even defect permanently in the coming weeks, shifting the whole balance of power.
It is another sign of mounting opposition in eastern Europe to IMF-mandated reforms and rescinding the VAT hike would probably send the leu currency and stocks plunging and even prompt review of debt ratings, analysts said.
Hungary's government said on Tuesday it would resume talks with the IMF and the EU in the autumn to bridge differences over a loan programme.
Talks about the review of an existing 2008 loan agreement collapsed unexpectedly last month, triggering a plunge in Hungarian assets.
A power shift in Romania would fuel concerns about whether the government can rein in its fiscal shortfall, targeted at 6.8 percent of GDP this year, and may even derail the whole rescue deal.
While most analysts believe the government can defend the VAT hike, there is still a significant risk of defeat.
“If they do reject it then we might not get a (1.2 billion euro) disbursement from the European Commission,” said Nicolaie Alexandru-Chidesciuc, chief economist at ING Bank in Bucharest.
“And the IMF deal is off-track,” he said. “Given fiscal consolidation is hit, then the central bank might allow considerable leu weakening to 4.4-4.5 per euro.”
If the government wins the VAT vote, it still faces a challenging few months and may try a small scale reshuffle before the winter in a bid to appease popular discontent.
The PSD, who say they would push for a re-negotiation of the IMF deal including scrapping Romania's flat profit and income tax, are riding high at nearly 40 percent in opinion polls.
The party would probably prefer to wait out the coming troubles and target a working majority of its own in 2012, as wider coalitions in 20 post-communist years have a history of internal bickering and dysfunction.
“Is the PSD forcing the Democrat-Liberals to govern until their disappearance,?” said Cotidianul newspaper editorialist Petru Berteanu. “The longer they stay in opposition the greater the chances for a good result in the general elections.”