WASHINGTON (MarketWatch) -- In 1995, the Romanian stock market was, as a local resident might put it, "fara sare si piper," or "without salt and pepper."

The Bucharest Stock Exchange (BVB) saw just 379 trades executed on its nine listed stocks, which had a total market value of about $100 million.

These days, the BVB is much more seasoned.

In 2004, the exchange's composite index rose 104 percent as Romanian and foreign investors bid up shares. The index climbed 50 percent higher so far this year, and as of Tuesday, the market capitalization of the 60 stocks hit a record $18 billion.

"Things are definitely looking up, finally," said Richard Segal, an economist and debt analyst with emerging-markets bond broker Exotix Ltd. in London. Romania's economy and political situation, he said, is "much better than it was, even four or five years ago."

The stock market's recent strength owes to "the Romanian economy on the whole," BVB Chief Executive Stere Farmache recently told a national newspaper. "Romania is today where most of the new EU (European Union) members used to be a few years ago."

Aiming to join the EU in 2007, Romania is struggling to transform itself from a corrupt and poor East European country into a modern member of the continental club. Now that a newly elected, reformist government has taken power, economic analysts are beginning to express qualified optimism in the nation's future.

The EU Prize

Bucharest has high hurdles to clear before winning EU membership. The new government must demonstrate it is improving competition and stamping out corruption.

New Prime Minister Calin Popescu Tariceanu, a wealthy businessman who took office Dec. 28, is trying to show observers and his people that Romania can do those very things.

"Don't judge Romania any more by what used to be," Tariceanu said in a Jan. 27 speech to business leaders. "It is true that the major changes won't happen overnight, but as of the day we took office, corruption and the arbitrary will of some bureaucrats are not any longer the law in Romania."

By any measure, Romania's recent economic picture has been grim. The country tottered badly in 1998, for example, when gross domestic product fell 4.8 percent. That same year, inflation stood at an annualized rate of 59 percent.

But by those same measurements, Romania's economy is now growing. Annual GDP growth has averaged about 5 percent since 2002, according to the International Monetary Fund. The IMF expects growth of 5 percent again in 2005.

The IMF also expects a further decline in inflation, to 7.3 percent in this year from 22.5 percent in 2002. Unemployment is seen falling to a projected 6.3 percent this year from 10.5 percent in 2000.

After enduring the 22-year dictatorship of Nicolae Ceausescu, the country is striving to gain a new measure of international respectability, solicit further foreign investment and replace its currency, the leu, with the euro.

To that end, Tariceanu introduced a 16 percent flat tax to replace corporate and personal income taxes that ranged from 18 and 40 percent for individuals and 25 percent for corporations. "We strongly support it as a source of wealth for all Romanians and foreign companies in Romania," he said in the Jan. 27 speech.

Talk like that pleases the U.S. government and American investors. But both note it is mostly talk so far.

What's critical in many observers' view is that Tariceanu's centrist-led coalition government follow through with its reform pledges. Business-contract enforcement in Romanian courts is weak, and privatization of state-owned assets has moved slowly in the face of a sometimes-recalcitrant government.

For their part, Tariceanu and President Traian Basescu pledge to hasten the state's decoupling from the economy and to cut bureaucratic red tape

"I am Romania's first liberal prime minister after communism," Tariceanu said. "This is the ground difference between what happens now and what used to be."

Courting foreign cash

By "liberal," Tariceanu means open to laissez-faire capitalism. That includes courting foreign investment. Major European and American companies already have set up shop in Romania, hoping to cash in on one of Eastern Europe's newest transitioning economies.

The flat tax should help attract new investment, and is already winning praise from the likes of Italy's minister for foreign trade. But it also apparently sparked worries about inflation. The IMF and Romania agreed earlier this month to cut this year's budget gap to 0.4 to 0.5 percent of GDP compared to 1.2 percent in 2004, according to a report from news agency Rompres.

Romania's foreign direct investment has lagged behind the rest of Eastern Europe's. But Coca-Cola , Solectron, Qualcomm , Procter & Gamble and Boeing are among the major U.S. companies that have invested in Romania. Those giants join European firms like Austria's OMV -- which owns Romanian energy company Petrom -- and France's Renault , which controls Dacia, the maker of Romania's ubiquitous automobile.

Privatization of state-owned assets has been under way for years, but some key sectors -- especially energy and financial services -- still are waiting for buyers. The Commercial Bank of Romania is on the block, for example, as is the Romanian Savings Bank. Both should garner interest from western banks this year, a U.S. official said.

Segal, the Exotix analyst, argues Romania's new government has much to lose if it doesn't follow through on its pledges to investors. "If you don't provide for legal certainty of investment, the EU is not going to let you in."

"A very developing society"

Soeren Rytoft also hopes the new government follows through. He should; he's investing other people's money in Romania.

Denmark-born Rytoft, executive strategist at Metzler/Payden Investment Advisors, is bullish on Romania, and it shows in the Metzler/Payden European Emerging Market Fund . The fund has five Romanian holdings, including energy giant Petrom, Banca Transilvania and turbojet component maker Turbomecanica.

"Romania is perhaps one of the newer countries that has developed a stock exchange...that you can really work with," says Los Angeles-based Rytoft.

There are two stock exchanges in Romania, the BVB and the over-the-counter market called the Rasdaq. The two are planning to merge in the middle of 2005, according to BVB chief Farmache.

Rytoft sees Romania, with its new government, growing along the lines of neighbors Poland, Hungary and the Czech Republic. "I believe the story will repeat itself," Rytoft says, as Romania's EU accession draws nearer. "You are seeing a very developing society in Romania," he says, noting increased demand for mortgage banking and credit cards.

The fund handily beats its peer group for returns, with its most recent one-year return at 50.36 percent compared to 15.74 percent for similar funds.

As of Feb. 18, Petrom had the exchange's largest market capitalization, with $9 billion. The oil giant's market value made up more than 50 percent of the Bucharest Stock Exchange's overall capitalization at the end of January.

Groupe Societe Generale S.A. is the largest private bank in Romania, with a market value of $2.7 billion. Part of a French banking group, it holds one-third of Romania's credit card market, according to company information, and about 20 percent of the country's loan market.

Oil company Rompetrol Rafinare was the BVB's third-most valuable company on Feb. 18, with a market capitalization of $719 million. Rompetrol is active mostly in the refining and marketing side of the oil business but also carries out exploration and production.

Aluminum company Alro S.A., which makes ingots, wire rods and billets, has a market value of $716 million. The company, based west of Bucharest in Slatina, makes 75 percent of its products for export, according to the company's web site. Export markets include Greece, Italy, Germany and Slovenia.

Banca Transilvania closed out the top five companies by market value as of Feb. 18. The first Romanian bank to be listed on the Bucharest Stock Exchange, according to the company, it had a market worth of $655 million.

Rytoft isn't the only one smiling on Romania these days. Within the past three months, two major agencies have upgraded the country's ratings. In November 2004, Fitch Ratings upped its outlook on Romania to "stable," and on Feb. 1, Standard & Poor's gave the country a "positive" rating.

"The outlook change is based on the commitment of the new centrist government to step up Romania's economic and institutional reforms, which will in turn solidify the prospect of Romania's timely accession to the EU in 2007," said S&P analyst Moritz Kraemer.

But Kraemer added that Romania must follow through with reforms before it earns the agency's "investment grade" rating.

"Maintaining a cautious policy mix, including prudent fiscal policies, will also be necessary for an upgrade in the next 12 months," he said.

At least one observer sees that upgrade, and another, coming.

"Fitch awarded the country an investment grade rating in November last year, and we expect S&P to make the same move in the second half of this year," Goldman Sachs' Neena Sapra wrote Feb. 2. "We also expect an upgrade by Moody's given that they rate Romania two notches below S&P, and that there has been no rating action since Dec. 2003."

Tariceanu, meanwhile, has his sights on a bigger prize. And S&P, Fitch, local business people and foreign investors - to say nothing of the average Romanian-will be watching how he and others go about pursuing it.

"It is the moment for profound structural modernization of the country," the prime minister told the Romanian Parliament on Dec. 28, 2004. "The next ten years shall make Romania reborn into a modern European country."