## ROMANIA — INTERNATIONAL MONETARY FUND, Selected Excerpts (cr18148)

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### Context and key macroeconomic findings
- Romanian economy growing strongly, driven by fiscal relaxation since 2016, rapid wage increases, and a favorable external environment.
- Growth surged to 6.9 percent in 2017, driven by private consumption and a tightening labor market.
- Signs of overheating: rising inflation (one of the highest in the EU), an expanding current account deficit, and slowing public investment with a declining share in the budget.
- Structural weaknesses: stalled SOE reforms, low quality of infrastructure, and deterioration in public spending composition.
- Monetary policy has started to respond, but monetary tightening alone would be a suboptimal policy mix for macroeconomic stabilization.

### Recent economic developments — inflation, external, fiscal, financial
- Inflation and monetary policy:
  - NBR inflation target: 2.5 ± 1 percent.
  - Headline inflation: 5 percent (y/y) in March 2018; above upper end of band since January 2018.
  - NBR actions: tightened corridor Oct–Nov 2017; raised policy rate by 25 basis points each in January and February 2018 (and again in May to 2.5 percent).
- External sector:
  - Current account deficit: 3.4 percent of GDP in 2017 (2016: 2.1 percent of GDP).
  - Goods trade deficit: 6.3 percent of GDP in 2017.
  - Net FDI flows: remained above 2 percent of GDP in 2017.
  - Reserve coverage: broadly adequate (Annex IV); gross international reserves: €37.1 billion at end-2017.
- Fiscal outcomes and composition:
  - 2017 headline general government deficit (cash basis): 2.8 percent of GDP; ESA deficit: about 2.9 percent of GDP.
  - Capital budget under-executed; share of public capital spending fell to lowest in a decade.
  - Wage bill increased by 0.6 percentage points of GDP.
  - Tax revenues declined by 1.1 percentage points of GDP relative to 2016.
  - 2017 revenue containment measures: social security contributions for part-time workers, reintroduction of fuel surcharge, higher dividend transfers from SOEs.
  - Staff assesses revenue gains from split-VAT and collection improvements will likely be less than budgeted.
- Financial sector and credit:
  - Stock of private credit: 27 percent of GDP.
  - Bank NPL ratio: 6.4 percent at end-2017 (peak 22 percent in 2014).
  - Mortgage lending experienced double-digit growth in 2017; household credit accelerated.
  - Corporate sector leverage increased due to sizable external funding and domestic trade credit reliance.

### Outlook and risks
- Growth projections:
  - Under current fiscal policies: real GDP growth could reach about 5 percent in 2018, led by consumption and accompanied by elevated inflation and a current account deficit.
  - Growth projected to remain above potential in 2018 and slow to around 3 percent in the medium term.
  - Lagging investment and limited structural reform progress would constrain potential growth below 4 percent.
- Macroeconomic buffers and vulnerability:
  - Current policies on trajectory to gradually erode buffers; government debt will keep rising steadily and could surge above 50 percent of GDP in the event of a growth shock (Annex I).
  - Monetary policy alone would not fully stabilize the economy and could leave inflation in the upper half of the target band.
  - Risks tilted to the downside: key external risk is sharper-than-expected tightening in global financial conditions; domestic risks include further deterioration in fiscal and external balances or weakening institutions.
  - Under adverse shocks, sharper monetary tightening could trigger volatile capital flows and exchange rate movements.

### Authorities’ views
- Government forecast assumes stronger near-term investment growth and stronger medium-term TFP growth (comparable to pre-crisis values).
- Authorities project growth at 6.1 percent for 2018, 5.7 percent during 2019–2020, and 5 percent in 2021.
- Fiscal authorities were less concerned about erosion of policy buffers over the medium term.

### Policy discussions and staff recommendations — overarching
- Improve policy mix via fiscal moderation, strengthen medium-term orientation and predictability of policies, and resume structural and governance reforms to improve business environment.
- Fiscal moderation and consolidation:
  - Staff: tighter fiscal stance than authorities’ target warranted in 2018 and over the medium term to reduce overheating and amount of monetary tightening required.
  - Authorities’ 2018 budget deficit target: 3 percent of GDP; staff-considered appropriate cyclical target: 2 percent of GDP.
  - Moving from authorities’ 3 percent target to a 2 percent target implies withdrawal of fiscal stimulus of ¾ percentage point of GDP.
  - To reach a 2 percent deficit, measures equivalent to about 1½ percentage points of GDP required because the authorities’ 3 percent target is not sufficiently supported by measures.
  - Staff suggests lowering the deficit further to 1.5 percent of GDP by 2020 to help transition to MTO of 1 percent of GDP.
  - To meet 2018 budget target, staff encouraged implementation of high-quality measures amounting to 0.6 percent of GDP that avoid further deterioration in budget structure and protect capital spending.
- Fiscal policy priorities to improve efficiency and composition:
  - Improve revenue collection: comprehensive review of tax system; rationalize exemptions; reform tax administration, especially VAT; implement and operationalize new IT infrastructure in revenue administration.
  - Bolster expenditure efficiency: prioritize large investment projects; conduct expenditure reviews; adopt centralized procurement.
  - Improve EU funds absorption: absorption rate for 2014–20 programming period: 13 percent through March 2018; better absorption would increase budget share of total capital spending and support consolidation.
- Other policy notes:
  - Monetary tightening alone is suboptimal; balanced fiscal-monetary mix needed.
  - Resume SOE reforms and strengthen governance.
  - FSAP provided recommendations to strengthen financial sector.

### Fiscal framework and Fiscal Responsibility Law (FRL)
- Romania enacted FRL in 2010 with a Fiscal Council, but fiscal rules in the FRL have not been observed.
- Staff: implementing all aspects of FRL would install a more coherent medium-term oriented fiscal framework with greater credibility.
- Recommendations:
  - Better integrate Fiscal Council’s advice into budget process.
  - Strengthen revenue mobilization and expenditure management to facilitate planning and FRL adherence.
  - Clarify potential changes to Pillar II pension system to remove uncertainty.
  - Conduct sustainability assessment for pension system while ensuring social protection objectives.

### Fiscal outlook, costs of 2018 measures, and consolidation menu (staff estimates; percent of GDP)
- Baseline/IMF estimates and recommended targets:
  - Budget deficit under current policies (IMF estimate): 2018 -3.6; 2019 -3.4; 2020 -3.3
  - Authorities' budget target: 2018 -3.0; 2019 -2.6; 2020 -1.9
  - IMF-recommended budget: 2018 -2.0; 2019 -1.5; 2020 -1.5
  - Measures needed (cumulative): 2018 1.6; 2019 2.1; 2020 2.1
  - Implied structural adjustment relative to previous year (IMF-recommended): 2018 0.8; 2019 0.5; 2020 0.2
  - Note: 2018 target of 2.96 percent of GDP in cash terms corresponds to around 3 percent in ESA terms.
- Fiscal Cost of New Measures Introduced in the 2018 Budget (Staff estimates, percent of GDP):
  - Revenue: -0.1
  - Personal income tax: -1.5
    - Lowering PIT on wages to 10 percent: -1.0
    - Other changes to PIT: -0.5
  - Social security contributions: 1.1
  - Other: 0.3
  - Expenditure: 2.0
    - Wages: 1.3
    - Pensions: 0.6
  - Total effect on the budget: 2.1
- Menu of possible measures for fiscal consolidation (Percent of GDP; cash basis). Estimated yield:
  - Postpone (or gradually implement) the pension point increase: 0.5
  - Reprioritize current expenditures (e.g. centralized procurement): 0.5
  - Revenue efficiency gains, broadening of the tax base: 0.3
  - Other measures (e.g. faster absorption of EU-funds): 0.2
  - Enforce the 10 percent buffer on current spending items: 0.1

### Box 1 — The Unified Wage Law and Change to Social Security Contributions (exact figures preserved)
- UWL adopted June 2017; raises public wages; implementation began January 2018; full effects expected by 2022.
- Authorities shifted largest part of employer share of social security contributions to employees and reduced social security contributions and PIT rates (by 2 and 6 percentage points, respectively).
- If changes are matched by about 20 percent increase in gross wages, tax wedge and net wage would not change.
- Changes can be broadly neutral for private sector but create uncertainty, increase administrative costs, and undermine predictability of tax policy.
- Illustration (exact figures preserved):
  - Gross wage (before taxes): Baseline 3,000; Proposed SSC shift 3,601
  - Social Security Contributions Rates: Baseline 39.3%; Proposed 37.3%
    - Employer: Baseline 22.8%; Proposed 2.3%
    - Employee: Baseline 16.5%; Proposed 35.0%
  - Personal Income Tax: Baseline 16%; Proposed 10%
  - Net wage (take home): Baseline 2,104; Proposed 2,106
  - Labor cost to employer: Baseline 3,683; Proposed 3,682
  - Total taxes to state: Baseline 1,578; Proposed 1,575
  - Social Security Contributions: Baseline 1,178; Proposed 1,341
  - Personal Income Tax: Baseline 401; Proposed 234
  - Tax wedge: Baseline 42.9%; Proposed 42.8%

### Box 2 — Options for Tax Revenue Mobilization (key figures preserved)
- Tax revenue dropped by about 2 percentage points of GDP since 2007.
- VAT findings:
  - VAT C-efficiency indicator in Romania: 0.5.
  - Romania’s VAT compliance gap: 37 percent (largest in the EU).
  - Closing VAT compliance gap to CESEE peers could raise VAT collection by 2 percentage points of GDP.
- Recommendations:
  - Develop a full service-oriented revenue body; extend use of IT.
  - Implement and operationalize new IT infrastructure—key priority.
  - Address constraints limiting large taxpayer administration.
  - Direct operational efforts toward mitigating key compliance risks.
- Evolution: revenue from income taxes and social security contributions dropped by 2 percentage points of GDP over 2008-16; recent changes risk being growth-harmful and have undermined public investment.

### Box 3 — Illustrating an Alternative Macroeconomic Policy Mix (scenario and results)
- Analytical framework: Flexible System of Global Models (FSGM).
- Alternative policy mix:
  - Fiscal consolidation targeting close to two percent of GDP in 2018 and 1½ percent of GDP into the medium term.
  - Fiscal package growth-friendly: tax reforms to raise collections (e.g., reduce VAT compliance gap), streamline expenditures, protect public investment.
  - Monetary policy tightening calibrated to fiscal trajectory to keep inflation within target band.
- Simulation results:
  - Strengthens fiscal and external balances while supporting lower inflation.
  - Fiscal tightening temporarily negative for growth, but allows monetary policy to be more accommodative, partially offsetting fiscal tightening.
  - Public debt-to-GDP ratio reduced by about 9 percentage points over the medium term.
  - Simulation conservative; does not reflect additional efficiency gains from tax administration and public administration reforms.

### Annex I — Debt Sustainability Analysis (selected figures)
- Public gross debt: 36.8 percent (current level), projected 42.0 percent in 2023.
- Gross public financing needs: 7.7 percent of GDP in 2017; projected to average around 7 percent of GDP.
- Baseline real GDP growth: 5.1 percent (2018), then 3.5 percent (2019), and 3.1 percent annually through 2023.
- Baseline inflation (GDP deflator): 3.6 percent (2018), then 3.0–3.3 percent through 2023.
- Baseline primary balance (percent of GDP): -2.3 percent (2018) improving to -1.8 percent by 2023.
- Effective interest rate (in percent): 3.4 (2018), rising to 4.1 by 2023.
- Identified debt-creating flows, cumulative 2018–2023: primary deficit contribution 12.0 (cumulative percent of GDP), automatic debt dynamics cumulative -6.6.
- Vulnerabilities:
  - Foreign-currency denominated debt: about half of total public debt.
  - Non-residents’ holdings of domestic-currency debt securities: 17.9 percent.
- Stress scenarios:
  - Combined macro-fiscal shock: debt about 57 percent by 2023.
  - Recession scenario: debt around 54–55 percent by 2023; public gross financing needs may reach or exceed 10 percent in stress years.
  - Stochastic: under asymmetric scenario there is 75 percent certainty debt will not exceed 60 percent of GDP in medium term.

### External debt and external sector (selected figures)
- Gross external debt: peak 74.6 percent of GDP in 2012; 49.7 percent of GDP in 2017.
- Short-term debt: 27 percent of total external debt in 2017.
- Inter-company lending: 29 percent of total external debt in 2017.
- Public external debt: 17.2 percent of GDP in 2017.
- NIIP: -45.7 percent of GDP at end-2017.
- Projected external debt (percent of GDP): 2017 49.7; 2018 48.8; 2019 47.1; 2020 45.9; 2021 44.8; 2022 42.9; 2023 41.0.
- Reserves and adequacy:
  - Gross international reserves: €37.1 billion at end-2017.
  - Reserves cover about 5.0 months of next year’s imports; exceed 150 percent of Fund’s reserves adequacy metric for emerging markets; cover over 50 percent of broad money; account for about 91 percent of short-term debt (remaining maturity).
- Policy implications:
  - Maintain prudent borrowing plans; monitor currency risks closely.
  - Limit public external borrowing to preserve low public external debt.
  - Use FX intervention sparingly to smooth excess volatility of the lei.

### Financial sector resilience and macroprudential recommendations (selected)
- Banking sector improvements:
  - Deposits from domestic private sector increased from about 48 percent of total bank liabilities in 2011 to about 64 percent in 2017.
  - Foreign-owned banks’ dependence on parent funding declined to about a third of 2011 levels.
  - NPLs declined significantly; corporate NPLs remain around 12 percent on average.
  - Housing loans increased from 21 to 54 percent of household loans between 2008 and 2017.
  - Romanian banking system sovereign exposure: around 20 percent of assets in 2017.
  - About 35 percent of banks’ liabilities and assets remain denominated in foreign exchange.
- Macroprudential recommendations (from FSAP and staff):
  - Impose a Debt-Service-to-Income (DSTI) limit on mortgage lending, applied to all mortgages including Prima Casa.
  - Gradually scale back the Prima Casa program.
  - Calibrate capital surcharges (preferably Systemic Risk Buffer) to address sovereign exposure vulnerabilities.
  - Monitor currency-differenciated NSFR and consider currency-differenciated LCR to mitigate FX liquidity risks.
  - Strengthen NCMO accountability: develop common assessment of systemic risk at each meeting and publicly disclose proposed policy actions and voting distribution.
  - Finalize Emergency Liquidity Assistance framework; establish liquidity facilities for the Bank Deposit Guarantee Fund.
  - Align provisioning regime across banks and NBFLs; monitor rising market share of NBFLs (10 percent of total loans in 2017).
- Legislative risks:
  - Warned against initiatives that could harm financial system (e.g., caps on interest rates for household lending; measures affecting NPL market functioning).
  - Authorities encouraged to assess implications of legislative initiatives on credit provision and NPL resolution.
- Implementation:
  - NBR agreed with main FSAP vulnerabilities and welcomed recommendations; initial steps taken to implement most FSAP recommendations.

### Macroprudential action plan (selected items and time frames)
- Apply a stressed DSTI limit to household loans and continue scaling back the Prima Casa program. Agencies: NBR, MoPF. Time Frame: NT.
- Enforce a currency-differentiated LCR and NSFR for significant currencies. Agency: NBR. Time Frame: NT.
- Introduce a carefully calibrated Systemic Risk Buffer. Agencies: NBR, MoPF, ASF. Time Frame: NT.
- Ensure provisioning requirements for NBFLs tighten in line with IFRS 9 application. Agencies: NBR, MoPF. Time Frame: NT.
- Strengthen supervisory tools, SREP consistency, corporate governance, PFMI adoption, cyber resilience staffing, AML/CFT preventive framework, ELA scheme, and crisis management arrangements (various agencies and time frames ranging NT, MT, I).

### Growth performance, vulnerabilities, and policy priorities (summary)
- One of highest growth rates in EU in 2017 with record low unemployment; signs of overheating: higher inflation and twin deficits.
- Investment has lagged consumption; structural reforms slowed.
- Policy priorities:
  - Bring 2018 deficit below cyclical neutral level to reduce burden on monetary policy and rebalance consumption and investment.
  - Avoid measures that worsen budget composition; protect capital spending.
  - Make tax changes predictable, avoid further tax rate cuts, improve tax collection (VAT focus), and operationalize new IT in revenue administration.
  - Re-energize structural reforms: strengthen public investment management, SOE governance (Law 111), and EU funds absorption; design sovereign investment fund and development bank mindful of risks.
  - Pace minimum wage increases considering competitiveness and productivity; establish transparent minimum wage mechanism.
  - Continue fight against corruption and strengthen AML/CFT frameworks.

### Operational and timing recommendation
- Recommended to hold the next Article IV consultation on standard 12-month cycle.

*Source: ROMANIA — INTERNATIONAL MONETARY FUND, chapter 1.*

### 1. The Unified Wage Law and Change to Social Security Contributions __________________________ 19

### 1. The Unified Wage Law and Change to Social Security Contributions __________________________ 19

### Context and key macroeconomic findings
- The Romanian economy is growing strongly, driven by fiscal relaxation since 2016, rapid wage increases, and a favorable external environment.
- Growth surged to 6.9 percent in 2017, driven by private consumption and a tightening labor market.
- Signs of overheating have emerged: rising inflation (one of the highest in the EU), an expanding current account deficit, and slowing public investment with a declining share in the budget.
- Structural weaknesses noted: stalled SOE reforms, low quality of infrastructure, and deterioration in public spending composition.
- Monetary policy has started to respond, but monetary tightening alone would be a suboptimal policy mix for macroeconomic stabilization.

### Recent economic developments — inflation, external, fiscal, financial
- Inflation and monetary policy:
  - NBR inflation target: 2.5 ± 1 percent.
  - Headline inflation reached 5 percent (y/y) in March 2018 and has been above the upper end of the band since January 2018.
  - The NBR tightened the corridor around the policy rate in October–November 2017 and raised the policy rate by 25 basis points each in January and February 2018.
- External sector:
  - Current account deficit: 3.4 percent of GDP in 2017 (2016: 2.1 percent of GDP).
  - Goods trade deficit: 6.3 percent of GDP in 2017.
  - Net FDI flows remained above 2 percent of GDP in 2017, largely due to reinvested earnings.
  - Reserve coverage remains broadly adequate (Annex IV).
- Fiscal outcomes and composition:
  - 2017 headline general government deficit (cash basis): 2.8 percent of GDP.
  - Corresponding ESA deficit: about 2.9 percent of GDP.
  - Capital budget under-executed; share of public capital spending fell to the lowest in a decade.
  - Wage bill increased by 0.6 percentage points of GDP.
  - Tax revenues declined by 1.1 percentage points of GDP relative to 2016 (contractions in VAT, excise, and corporate income tax revenue).
  - Revenue containment measures in 2017 included introduction of social security contributions for part-time workers and reintroduction of the fuel surcharge; higher dividend transfers from SOEs also helped contain the deficit.
  - Staff assesses revenue gains from split-VAT and collection improvements will likely be less than budgeted.
- Financial sector and credit:
  - Stock of private credit: 27 percent of GDP (one of the lowest in the EU).
  - Bank NPL ratio: 6.4 percent at end-2017 (peak of 22 percent in 2014).
  - Mortgage lending experienced double-digit growth in 2017; household credit accelerated.
  - Corporate sector leverage has increased due to sizable external funding and reliance on domestic trade credit.

### Outlook and risks
- Growth projections:
  - Under current fiscal policies, real GDP growth could reach about 5 percent in 2018, led by consumption and accompanied by elevated inflation and a current account deficit.
  - Growth is projected to remain above potential in 2018 and slow to around 3 percent in the medium term.
  - Lagging investment and limited structural reform progress would constrain potential growth below 4 percent.
- Macroeconomic buffers and vulnerability:
  - Current policies are on a trajectory to gradually erode buffers; government debt will keep rising steadily and could surge above 50 percent of GDP in the event of a growth shock (Annex I).
  - Monetary policy alone would not fully stabilize the economy and could leave inflation in the upper half of the target band.
  - Risks are tilted to the downside (Annex II): key external risk is a sharper-than-expected tightening in global financial conditions; domestic risks include further deterioration in fiscal and external balances or weakening institutions.
  - Under adverse shocks, sharper monetary tightening could trigger volatile capital flows and exchange rate movements.

### Authorities’ views
- The government forecast assumes stronger near-term investment growth and stronger medium-term TFP growth (comparable to pre-crisis values).
- Authorities project growth at 6.1 percent for 2018, 5.7 percent during 2019–2020, and 5 percent in 2021.
- Fiscal authorities were less concerned about erosion of policy buffers over the medium term.

### Policy discussions and staff recommendations
- Overarching recommendation:
  - Improve the policy mix via fiscal moderation, strengthen medium-term orientation and predictability of policies, and resume structural and governance reforms to improve the business environment.
- Fiscal moderation and consolidation:
  - Staff view: a tighter fiscal stance than the authorities’ target is warranted in 2018 and over the medium term to reduce overheating and the amount of monetary tightening required.
  - Authorities’ 2018 budget deficit target: 3 percent of GDP; staff considers a more appropriate deficit target from a cyclical perspective to be 2 percent of GDP.
  - Implication: moving from the authorities’ 3 percent target to a 2 percent target implies a withdrawal of fiscal stimulus of ¾ percentage point of GDP.
  - To reach a 2 percent deficit, measures equivalent to about 1½ percentage points of GDP would be required because the authorities’ 3 percent target is not sufficiently supported by measures.
  - Staff suggests lowering the deficit further to 1.5 percent of GDP by 2020 to help transition to the medium-term objective (MTO) of 1 percent of GDP.
  - To meet the 2018 budget target, staff encouraged the authorities to implement high-quality measures amounting to 0.6 percent of GDP that avoid further deterioration in budget structure and protect capital spending.
- Fiscal policy priorities to improve efficiency and composition:
  - Improving revenue collection:
    - Significant scope to strengthen revenue collection (Box 2).
    - Tax changes should be more predictable and less frequent; further tax rate cuts should be avoided.
    - Conduct a comprehensive review of the tax system; rationalize exemptions; reform tax administration, especially VAT.
    - Implement and operationalize new IT infrastructure in revenue administration given outdated systems.
  - Bolstering expenditure efficiency:
    - Enforce prioritization of large investment projects and reflect this in annual budgets.
    - Conduct expenditure reviews for key sectors to identify efficiency gains.
    - Adopt a centralized procurement system to generate savings on goods and services spending.
    - MoPF plans to make progress in these areas were welcomed by staff.
  - More efficient absorption of EU funds:
    - Absorption rate of EU funds for programming period 2014–20: 13 percent through March 2018.
    - Better absorption, especially for large infrastructure projects, would increase the budget share of total capital spending while supporting fiscal consolidation.
- Other policy notes:
  - Monetary tightening alone would be suboptimal; a balanced fiscal-monetary mix is needed to maintain macro-financial stability.
  - Resume SOE reforms and strengthen governance to more sustainably achieve inclusive convergence with advanced EU living standards.
  - FSAP has provided recommendations to strengthen the financial sector.

*Source: ROMANIA — INTERNATIONAL MONETARY FUND, chapter 1.*

### 17.      The fiscal responsibility law (FRL) could enhance policy predictability. Romania enacted

### 17.      The fiscal responsibility law (FRL) could enhance policy predictability.

### Fiscal framework and FRL implementation
- Romania enacted in 2010 a sound FRL to strengthen fiscal discipline and budget formulation, with a Fiscal Council being put in place.
- The fiscal rules in the FRL have not been observed.
- Staff view: implementing all aspects of the FRL would install a more coherent and medium-term oriented fiscal framework with greater credibility.
- Recommendation: better integrate the Fiscal Council’s advice into the budget process.
- Recommendation: stronger revenue mobilization and expenditure management would make it easier to plan ahead and abide by the FRL.
- Recommendation: clarify potential changes to the Pillar II pension system to remove associated uncertainty.
- Recommendation: conduct a sustainability assessment for the pension system while continuing to ensure that its social protection objectives are met.

### Fiscal outlook and staff recommendations (Figure 2)
- Staff assessment: given the current cyclical position, a tighter fiscal stance will help improve the policy mix and rebuild fiscal buffers.
- Under the baseline scenario with current policies, the deficit will reach 3.6 percent of GDP in 2018 and public debt will gradually rise over the medium term.
- The wage and pension increases implemented in 2018 are costly and place pressure on government finances.
- High-quality near-term measures should be implemented to meet the government’s 3 percent of GDP deficit target for 2018 and the staff-recommended 2 percent target.
- Fiscal Cost of New Measures Introduced in the 2018 Budget (Staff estimates, percent of GDP):
  - Revenue: -0.1
  - Personal income tax: -1.5
    - Lowering PIT on wages to 10 percent: -1.0
    - Other changes to PIT: -0.5
  - Social security contributions: 1.1
  - Other: 0.3
  - Expenditure: 2.0
    - Wages: 1.3
    - Pensions: 0.6
  - Total effect on the budget: 2.1
- Menu of possible measures for fiscal consolidation (Percent of GDP; cash basis). Estimated yield:
  - Postpone (or gradually implement) the pension point increase: 0.5
  - Reprioritize current expenditures (e.g. centralized procurement): 0.5
  - Revenue efficiency gains, broadening of the tax base: 0.3
  - Other measures (e.g. faster absorption of EU-funds): 0.2
  - Enforce the 10 percent buffer on current spending items: 0.1
- Fiscal Balance Targets (Percent of GDP; cash basis):
  - Budget deficit under current policies (IMF estimate): 2018 -3.6; 2019 -3.4; 2020 -3.3
  - Authorities' budget target: 2018 -3.0; 2019 -2.6; 2020 -1.9
  - IMF-recommended budget: 2018 -2.0; 2019 -1.5; 2020 -1.5
  - Measures needed (cumulative): 2018 1.6; 2019 2.1; 2020 2.1
  - Implied structural adjustment relative to previous year (IMF-recommended): 2018 0.8; 2019 0.5; 2020 0.2
- Note: The 2018 target of 2.96 percent of GDP in cash terms corresponds to around 3 percent in ESA terms.

### Authorities’ fiscal views and actions
- Authorities committed to stronger fiscal management and the EU deficit limit of 3 percent of GDP, but not to a further reduction in the 2018 deficit proposed by the mission.
- Agreed priorities: higher capital expenditure, more effective EU funds absorption, more efficient spending, and stronger revenue collection.
- The MoPF is requesting FAD TA on tax administration.
- Authorities are setting up the National Center for Financial Information (CNIF) within the MoPF to unify fiscal information databases, including ANAF.

### Monetary tightening and policy mix
- Staff advocated a better fiscal-monetary policy mix: fiscal moderation would reduce the burden on monetary policy and help rebalance consumption and investment.
- Given signs of overheating—rising inflation and tight labor markets—prompt macroeconomic stabilization is needed to reduce risks for a hard landing.
- If stabilization is left to monetary policy alone, interest rates would have to be raised to levels that increasingly weigh on investment and competitiveness.
- Monetary policy needs further tightening to rein in inflation and anchor expectations.
- Inflationary pressure sources: global energy prices, strong domestic demand, wage increases, and recent currency dynamics reflecting the anticipated fiscal impulse and positive output gap in 2018.
- Headline inflation is projected to persist above the target band until the end of 2018.
- Policy recommendations:
  - Central bank should remain independent and refrain from stimulating activity at the cost of higher inflation.
  - Mission encouraged the NBR to continue raising the policy rate in a frontloaded manner, while managing liquidity to align market and policy rates.
  - Sharper adjustments at a later stage could trigger destabilizing capital flows and exchange rate changes.
- Staff noted that the recent monetary tightening was a welcome start and underscored the need to strengthen monetary transmission.

### External position
- Staff assessed Romania’s external position in 2017 as broadly in line with underlying fundamentals (Annex IV).
- The three EBA-lite models suggest a moderate REER undervaluation of around 1–7 percent.
- Reserve coverage is broadly adequate according to all reserve adequacy metrics.
- At times in 2017, the NBR increased FX sales due to seasonal trends and when the currency came under pressure in a still somewhat shallow market.
- Staff advice: limit interventions only to smoothing excess volatility of the lei.

### Structural reforms
- Re-energizing structural reforms is essential to strengthen convergence with the EU and alleviate constraints on growth.
- Progress noted: strengthening the judiciary and the fight against corruption and floating minority stakes in key SOEs.
- Law 111 on corporate governance (2016) strengthened professional and transparency requirements for SOE management.
- Earlier reform momentum has waned; renewed reform momentum is called for.
- Effective absorption of EU funds can help address Romania’s large infrastructure gap; infrastructure quality is the lowest in the EU (especially road and rail).
- Raising the EU funds absorption rate to 95 percent for programming period 2014–20 on quality projects could bring about a 10-percent increase in the 2022 GDP beyond the baseline.
- Recommendations:
  - Improve administrative capacity, especially at line ministries, to ensure higher absorption rates and funds applied to priority areas.
  - Ensure timely preparation of new projects based on strong feasibility assessments for a smooth transition into the next EU funds programming period.
- SOE reform:
  - Resume restructuring and privatization, including initial public offerings, to improve service and financial performance of many SOEs.
  - Do not weaken Law 111; strengthen implementation and monitoring, including by building capacity of the MoPF unit and line ministries overseeing SOE reform.
  - Government plans to establish a sovereign investment fund with shares of SOEs and a development bank; staff cautioned on risks and advised following international best practices on governance, reporting, and management of fiscal risks.
- Minimum wage:
  - Minimum wage more than doubled since 2011; minimum-to-average wage ratio surpassed the regional average in 2016.
  - Recommendation: pace of future minimum wage increases should consider competitiveness, productivity growth, and employment prospects.
  - Recommendation: establish a transparent minimum wage mechanism based on objective criteria (as proposed in SM/16/94) and endorsed by social partners.
- Anti-corruption and AML/CFT:
  - Progress in fight against corruption has been recognized internationally and needs to continue.
  - Recent initiatives seen as threatening judicial independence; authorities encouraged to continue strengthening the AML/CFT framework in compliance with FATF standards (e.g., comprehensive assessment of ML/TF risks, customer due diligence for politically exposed persons, enhancing entity transparency, strengthening asset declaration framework for senior officials).

### Financial sector resilience
- Banking sector improvements:
  - Banks’ profitability and liquidity positions have strengthened.
  - Foreign-owned banks’ dependence on parent funding declined to about a third of the level in 2011.
  - Deposits from the domestic private sector increased from about 48 percent of total bank liabilities in 2011 to about 64 percent in 2017.
  - NPLs declined significantly, though NPLs for corporates remain around 12 percent on average.
- Vulnerabilities:
  - High exposure to real estate and sovereign debt.
  - Housing loans increased from 21 to 54 percent of household loans between 2008 and 2017.
  - Romanian banking system sovereign exposure was around 20 percent of assets in 2017 (one of the highest in the EU).
  - About 35 percent of banks’ liabilities and assets remain denominated in foreign exchange.
- Macroprudential recommendations (drawing on FSAP conclusions, Annex V):
  - Impose a Debt-Service-to-Income (DSTI) limit on mortgage lending, applied to all mortgages including Prima Casa.
  - Gradually scale back the Prima Casa program (staff welcomed government’s strategy).
  - Calibrate capital surcharges (preferably the Systemic Risk Buffer) to address sovereign exposure vulnerabilities while avoiding unintended market impacts.
  - Monitor a currency-differenciated Net Stable Funding Ratio and consider a currency differenciated Liquidity Coverage Ratio to mitigate FX liquidity risks.
  - Strengthen NCMO accountability: develop a common assessment of systemic risk at each meeting and publicly disclose proposed policy actions and voting distribution.
- Supervisory and crisis framework recommendations:
  - Develop processes supporting banks’ supervisory review and finalize Emergency Liquidity Assistance framework.
  - Central bank should establish liquidity facilities for the Bank Deposit Guarantee Fund.
  - Align provisioning regime across banks and NBFLs; monitor rising market share of NBFLs (10 percent of total loans in 2017).
  - Recent NBR regulation to strengthen oversight of larger NBFLs is encouraging.
- Legislative risks:
  - Staff warned against initiatives that could harm the financial system (e.g., caps on interest rates for household lending; measures affecting NPL market functioning).
  - Mission encouraged authorities to assess legislative initiatives' implications on credit provision and NPL resolution.
- Authorities’ views:
  - NBR agreed with main vulnerabilities identified by the FSAP and welcomed its recommendations.
  - Initial steps have been taken to implement most FSAP recommendations.
  - NCMO likely to take more time to adopt capital surcharges for banks’ sovereign debt holdings.
  - NBR has provided impact assessments in response to legislative initiatives that could harm the financial system.

*IMF staff and Romanian authorities, as presented in the IMF staff report.*

### 35.      Economic growth in Romania has been strong in recent years, but policy changes will

### Economic growth in Romania has been strong in recent years, but policy changes will be required to protect policy buffers.

### Growth performance and vulnerabilities
- One of the highest growth rates in the EU in 2017 accompanied by record low unemployment and improved financial sector conditions.
- Signs of overheating: higher inflation and twin deficits eroding resilience to shocks.
- Romania’s external position is described as still broadly in line with underlying fundamentals.
- Investment has lagged consumption, and structural reforms have slowed, hampering broader and more inclusive convergence with the advanced EU countries over the medium term.

### Fiscal stance, targets, and needed measures
- A smaller-than-budgeted fiscal deficit in 2018 would improve the fiscal-monetary policy mix and increase medium-term resilience.
- Bringing the 2018 deficit below a cyclically neutral level would:
  - Reduce the burden on monetary policy.
  - Improve the balance between consumption and investment.
  - Be a first step towards reaching Romania’s medium-term budgetary objective under EU rules.
- Relative to current policies, additional measures will likely be needed to meet the authorities’ budget deficit target of 3 percent of GDP in 2018, and to reach staff’s recommended lower deficit target.
- Design of deficit-reducing measures should:
  - Avoid further deterioration of the budget structure.
  - Protect capital spending to reverse recent squeezing of capital spending and the increase in the share of rigid spending.
  - Stop the decline in tax revenues driven by tax rate cuts and weakening tax compliance.

### Improving fiscal efficiency and revenue mobilization
- Romania’s declining and comparatively low tax revenue highlights the importance of effective revenue mobilization and expenditure management.
- Policy guidance:
  - Make tax changes more predictable and less frequent; avoid further tax rate cuts.
  - Improve tax collection efficiency, including by reforming tax administration for the VAT and operationalizing new IT infrastructure in revenue administration.
  - Bolster expenditure efficiency by undertaking expenditure reviews for key sectors and adopting a centralized procurement system.
  - Continue efforts to improve EU funds absorption, especially at line ministries, to increase total capital spending while supporting fiscal consolidation.

### Monetary policy stance and recommendations
- Inflation is expected to remain elevated through most of 2018.
- Recommendations for the National Bank of Romania (NBR):
  - Continue tightening monetary policy to curb inflation and anchor expectations.
  - Continue raising the policy rate in a frontloaded manner.
  - Manage liquidity to align market and policy rates.
  - Uphold central bank independence to buttress monetary policy credibility.
  - Limit interventions in the foreign exchange market to smoothing excessive volatility.

### Structural reforms and institutional priorities
- Re-energize structural reforms to strengthen growth potential and accelerate convergence.
- Priorities include:
  - Strengthening public investment management institutions to absorb EU funds more effectively and address Romania’s large infrastructure gap.
  - Improving SOE performance through renewed commitment to strong corporate governance—including the governance standards codified in Law 111—and ongoing restructuring.
  - Designing plans for a sovereign investment fund and a development bank to reflect international experiences and best practices, mindful of associated risks.
  - Establishing a transparent minimum wage mechanism based on objective criteria to balance social and competitiveness implications.
  - Continue progress in the fight against corruption.

### Financial sector resilience and FSAP recommendations
- Banks are well capitalized and liquid with NPLs now close to EU averages, but vulnerabilities remain from bank exposures to the government and the real estate sector.
- Recommended macroprudential and supervisory actions:
  - Consider a debt-service-to-income limit on mortgage lending.
  - Consider a carefully calibrated capital surcharge for sovereign exposures.
  - More proactive management of FX liquidity risks.
  - Bolster supervisory practices and the crisis management framework, including:
    - Finalizing the framework for Emergency Liquidity Assistance.
    - Aligning provisioning regimes across banks and NBFLs.
- Legislative initiatives that harm the financial system should be avoided.

### Recommendation on consultation timing
- It is recommended to hold the next Article IV consultation on the standard 12-month cycle.

### Box 1 — The Unified Wage Law and Change to Social Security Contributions
- The Unified Wage Law (UWL), adopted in June 2017, significantly raises public wages; implementation began in January 2018, with full effects expected to materialize in 2022.
- To mitigate fiscal costs of the UWL, authorities shifted the largest part of the employer share of social security contributions to employees and reduced social security contributions and PIT rates (by 2 and 6 percentage points, respectively).
- If these changes are matched by about 20 percent increase in gross wages, the tax wedge and net wage would not change.
- The changes can be broadly neutral for the private sector but create uncertainty, increase administrative costs, and undermine predictability of tax policy.
- Illustration (exact figures preserved):
  - Gross wage (before taxes): Baseline 3,000; Proposed SSC shift 3,601
  - Social Security Contributions Rates: Baseline 39.3%; Proposed 37.3%
    - Employer: Baseline 22.8%; Proposed 2.3%
    - Employee: Baseline 16.5%; Proposed 35.0%
  - Personal Income Tax: Baseline 16%; Proposed 10%
  - Net wage (take home): Baseline 2,104; Proposed 2,106
  - Labor cost to employer: Baseline 3,683; Proposed 3,682
  - Total taxes to state: Baseline 1,578; Proposed 1,575
  - Social Security Contributions: Baseline 1,178; Proposed 1,341
  - Personal Income Tax: Baseline 401; Proposed 234
  - Tax wedge: Baseline 42.9%; Proposed 42.8%

### Box 2 — Options for Tax Revenue Mobilization
- Tax collection in Romania is low compared to peers, mostly due to lower collection of value added tax (VAT) and social security contributions.
- Tax revenue in Romania dropped by about 2 percentage points of GDP since 2007.
- VAT-specific findings:
  - VAT C-efficiency indicator in Romania: 0.5 (lower than other CESEE or advanced EU countries at 0.6).
  - Romania’s VAT compliance gap is the largest in the EU: 37 percent.
  - Closing the VAT compliance gap to CESEE peers could raise VAT collection in Romania by 2 percentage points of GDP.
- For PIT and CIT, efficiency indicators in Romania are close to other CESEE countries but still below advanced EU countries.
- Strengthening tax administration is crucial:
  - Develop a full service-oriented revenue body and simplify tax fulfilment through extended use of information technology.
  - Implement and operationalize new IT infrastructure—identified as a key priority given outdated and fragile systems.
  - Address legislative, procedural, and structural constraints limiting large taxpayer administration.
  - Establish strategies and processes to direct operational efforts toward mitigating key compliance risks.
- Evolution of revenue structure and growth implications:
  - The tax burden shifted away from growth-harmful taxes—revenue from income taxes and social security contributions dropped by 2 percentage points of GDP over 2008-16.
  - Up until 2011, VAT broadly compensated this revenue loss; more recent changes to social security contributions (see Box 1) together with continuous reduction in VAT collection since 2011 could be growth-harmful.
  - The reduction in overall tax revenue has undermined public investment, with negative implications for growth.

*IMF staff report: Romania — selected excerpts.*

### Box 3. Illustrating an Alternative Macroeconomic Policy Mix 1/

### Box 3. Illustrating an Alternative Macroeconomic Policy Mix

### Context and analytical framework
- Romania is growing above potential.
- The Flexible System of Global Models (FSGM) is used to simulate the impact of different fiscal and monetary policy mixes on the Romanian economy.
- Staff’s baseline: fiscal deficits around 3 percent of GDP into the medium term and even substantial monetary tightening; inflation remains around the top-end of the target band and fiscal buffers are further eroded, increasing vulnerability.

### Alternative policy mix (scenario design)
- Fiscal consolidation that targets the fiscal deficit:
  - Close to two percent of GDP in 2018.
  - 1½ percent of GDP into the medium term.
- Fiscal package characteristics:
  - Growth friendly.
  - Centered on tax reforms to raise collections (e.g., reduce the VAT compliance gap).
  - Streamlining of expenditures for efficiency, while protecting public investment.
- Monetary policy:
  - Monetary policy tightening calibrated to the fiscal trajectory to keep inflation within the target band.

### Simulation results and key quantitative outcomes
- The improved policy mix helps strengthen fiscal and external balances, while supporting lower inflation.
- Short-term and medium-term growth effects:
  - Fiscal tightening would temporarily have a negative impact on growth.
  - Allows monetary policy to be more accommodative compared to the baseline, partially offsetting fiscal tightening, resulting in a small combined aggregate effect on growth.
  - The mix would avoid interest rates having to be raised to levels that weigh on private investment and competitiveness, thus supporting improved potential growth in the medium term.
- Public debt:
  - The public debt-to-GDP ratio would be reduced by about 9 percentage points over the medium term.
- Conservatism of simulation:
  - The simulation is conservative and does not reflect that part of the recommended fiscal adjustment is embedded in measures to improve the tax system and public administration, which would help enhance economic efficiency, better the business environment, and ease shortages in the labor market.

### Implications for policy
- Combining fiscal moderation with monetary policy calibrated to the fiscal path can:
  - Reduce vulnerabilities associated with eroding fiscal buffers.
  - Keep inflation within the target band without excessive tightening that would harm private investment and competitiveness.
  - Support a better balance between near-term stabilization and medium-term potential growth through protected public investment and growth-friendly revenue measures.

*Prepared by Zoltan Jakab (RES) and Seng Guan Toh (EUR).*

### Annex I. Debt Sustainability Analysis

### Annex I. Debt Sustainability Analysis

### Overview
- Public debt in Romania is expected to remain relatively low but rise gradually over the medium term.
- Under the baseline scenario, the public debt-to-GDP ratio is projected to reach 42 percent by 2023 from the current level of 36.8 percent.
- Gross public financing needs (7.7 percent of GDP in 2017) are expected to remain contained below 10 percent over the projection horizon.
- The combined macro-fiscal shock pushes the debt trajectory most significantly, raising debt to about 57 percent by 2023.
- In the recession scenario debt reaches around 54 percent by 2023.
- Exchange rate volatility and exposure to international capital outflows are notable risks; debt profile vulnerability indicators exceed the upper early warning benchmarks.

### Comparison with the Previous Assessment
- The baseline debt trajectory is lower relative to last year’s DSA.
- 2017 outturns were better than expected: fiscal balance outturn of 2.8 percent of GDP versus 3.7 percent in the 2017 DSA; real growth outturn of 6.9 percent versus 4.2 percent in the 2017 DSA.
- Drivers of the lower medium-term trajectory:
  - (i) lower base in 2017,
  - (ii) lower projected deficits for 2018 and 2019 compared to 2017 DSA,
  - (iii) higher projected growth for 2018 and 2019 compared to 2017 DSA.
- Under the baseline, incorporating all legislated fiscal loosening measures, the budget deficit is expected to exceed 3 percent over 2018-2023—thus violating the 3 percent rule under the Stability and Growth Pact—without additional measures.
- The budget deficit is projected to gradually decline after 2019, reaching 3.2 percent of GDP by 2023 as absorption of EU-funds improves and replaces capital spending financed directly out of the budget.

### Baseline and Realism of Projections
- Debt level:
  - Gross debt level (including guarantees) is projected to rise gradually, reaching 42 percent in 2023.
  - Gross financing needs over the same period are projected to remain well-below 10 percent of GDP, averaging around 7 percent of GDP.
- Fiscal balance and adjustment:
  - The budget deficit worsens in 2018 before gradually improving and reaching 3.2 percent of GDP in 2023.
  - 2018 deterioration driven mainly by wage increases effective January 1, 2018, and pension increases expected effective July 1, 2018.
  - Projections incorporate macroeconomic variables and the assumption that absorption of EU funds will gradually improve over the medium term.
  - Projected 3-year adjustment in the cyclically-adjusted primary balance (CAPB) is 0.5 percent of GDP, indicating potential additional room for adjustment; the 3-year average CAPB places Romania at the lower end of comparator countries’ distribution.
- Growth:
  - Current real GDP growth projection of 5.1 percent for 2018 (IMF staff) is lower than the authorities’ forecast of 6.1 percent.
  - Medium-term growth expected to stabilize at 3.1 percent of GDP.
  - Boom-bust analysis is not triggered because the three-year cumulative change in the credit-to-GDP ratio does not exceed 15 percent in Romania.
- Maturity, rollover and other risks:
  - Authorities maintain a foreign currency financing buffer (excluding privatization proceeds).
  - Most longer-term debt consists of official financing; average maturity of government securities on the domestic market is 3.3 years.
  - Public debt is vulnerable to exchange rate risk: foreign currency denominated debt accounts for about half of total public debt; non-residents’ share in domestic-currency debt securities holdings is 17.9 percent.
  - Reliance on temporary financing increased sharply in 2017 and could negatively impact liquidity and refinancing risks.
  - Note: Public debt according to Romania’s national legislation includes temporary financing from the State Treasury General Current Account (intra-governmental debt) and is excluded from gross debt figures reported in this DSA.

### Stochastic Simulations
- Fan charts based on symmetric and asymmetric risk distributions illustrate possible debt ratio evolution.
- Under the symmetric distribution, there is a high level of certainty that debt will remain below 60 percent of GDP over the medium term.
- Under the asymmetric (restricted) scenario—where it is assumed there are no positive shocks to the primary balance—there is a 75 percent certainty that debt will not exceed 60 percent of GDP in the medium term.

### Stress Tests and Scenario Results
- Real GDP growth shock:
  - Debt ratio remains under 60 percent of GDP under all scenarios,
  - Most sensitive to the real GDP growth shock, under which debt reaches about 51 percent of GDP.
  - This scenario results in public gross financing needs in 2019 and 2020 reaching the 10 percent threshold.
  - Recession scenario (assumes growth of 0.5 percent in 2019 with gradual recovery): public debt reaches 55 percent in 2023 and public gross financing needs average around 10 percent of GDP over the medium term.
- Combined shock:
  - Incorporates largest effects of individual shocks on real GDP growth, inflation, primary balance, exchange rate and interest rate.
  - Under this scenario, debt would reach 57 percent of GDP in 2023 without showing a declining trajectory.
  - Gross financing needs peak at around 11 percent of GDP in 2020, averaging about 10 percent in the remaining projection years.
- Contingent liability shock:
  - Including a contingent liability shock, barring unexpected events, the effect on public debt of potential contingent liabilities would be limited.
  - SOE debt is estimated at around 7 percent of GDP (including SOEs under insolvency procedures).

### Key Statistics and Projections (selected figures)
- Public gross debt: 36.8 percent (current level), projected 42.0 percent in 2023.
- Gross public financing needs: 7.7 percent of GDP in 2017; projected to average around 7 percent of GDP.
- Baseline real GDP growth: 5.1 percent (2018), then 3.5 percent (2019), and 3.1 percent annually through 2023.
- Baseline inflation (GDP deflator): 3.6 percent (2018), then 3.0–3.3 percent through 2023.
- Baseline primary balance (percent of GDP): -2.3 percent (2018) improving to -1.8 percent by 2023.
- Effective interest rate (in percent): 3.4 (2018), rising to 4.1 by 2023.
- Identified debt-creating flows, cumulative 2018–2023: primary deficit contribution 12.0 (cumulative percent of GDP), automatic debt dynamics cumulative -6.6.
- Composition and vulnerabilities:
  - Foreign-currency denominated debt: about half of total public debt.
  - Non-residents’ holdings of domestic-currency debt securities: 17.9 percent.

*Source: IMF staff.*

### 9.      The external debt continues the downward trend. After peaking in 2012 at 74.6 percent

### 9.      The external debt continues the downward trend. After peaking in 2012 at 74.6 percent

### Recent developments
- Gross external debt peaked in 2012 at 74.6 percent of GDP and declined to 49.7 percent of GDP in 2017.
- Private sector deleveraging, both in banking and non-banking sectors, has been the main driver of the declining debt.
- Short-term debt accounted for 27 percent of total external debt in 2017.
- Inter-company lending stands at 29 percent of total external debt in 2017 and largely covers short-term debt.
- Public external debt was 17.2 percent of GDP in 2017 and "remains low by international standards."
- Romania’s net international investment position (NIIP) was -45.7 percent of GDP at end-2017 and has continued to improve as a share of GDP over the last five years.

### Projections and debt path (baseline)
- The external debt is expected to decline to around 41 percent of GDP in 2023, driven largely by nominal GDP growth and modest borrowing plans.
- Baseline external debt trajectory (selected years, In percent of GDP):
  - 2017: 49.7
  - 2018: 48.8
  - 2019: 47.1
  - 2020: 45.9
  - 2021: 44.8
  - 2022: 42.9
  - 2023: 41.0
- Identified external debt-creating flows and changes contributed to the projected decline (see table for decomposition of current account, net non-debt inflows, automatic debt dynamics, and residuals).

### Vulnerabilities and stress-test results
- Roll-over risk of the non-banking sector is limited because almost all short-term exposure stems from inter-company lending.
- Staff analysis: debt dynamics are resilient to shocks to interest rate, growth rate, current account, or combined shocks — debt continues to decline under these shocks, though at a slower pace.
- A stress scenario with a 30 percent real depreciation produces a sharp increase in external debt to over 70 percent of GDP in 2019, and thereafter a gradual decline to around 60 percent of GDP in 2023.
- Bound tests and alternative scenarios (interest rate shock, CA shock, combined shock, growth shock) are presented, showing the real depreciation scenario as the most severe for external debt dynamics.

### External sector: current account, reserves, competitiveness
- Current account: a deterioration in 2017 relative to 2016 due to higher domestic demand; staff’s EBA-lite tool estimates a cyclically-adjusted CA norm of -3.9 percent of GDP and a CA gap of 0.9 percent of GDP.
- Financing: FDI inflows financed about two-thirds of the current account deficit in 2017; majority of FDI are reinvested earnings. Portfolio flows picked up in 2017 on account of sovereign bond issuance.
- Real exchange rate: CPI-based REER depreciated by 1.6 percent in 2017; unit labor cost increased about 11.3 percent and the ULC-based REER appreciated about 5 percent.
- EBA-lite implications: an appreciation of 1.4 percent would close the CA gap and stabilize NIIP at 45.9 percent of GDP; EBA-lite CA and REER models imply undervaluation of 1.3 and 6.9 percent respectively; staff’s overall assessment is that the real exchange rate is broadly in line with fundamentals.
- Reserves and adequacy:
  - Gross international reserves stood at €37.1 billion at end-2017.
  - Reserves exceed 150 percent of the Fund’s reserves adequacy metric for emerging markets.
  - Reserves cover about 5.0 months of next year’s imports.
  - Reserves cover over 50 percent of broad money.
  - Reserves account for about 91 percent of short-term debt (at remaining maturity).
- Staff advises limiting foreign exchange interventions to smoothing excess volatility of the lei, given projected reserve decline in 2018 and high share of FX lending.

### Policy implications and recommendations
- Maintain prudent borrowing plans and allow nominal GDP growth to support further declines in external debt.
- Monitor currency risks closely: sharp real depreciation is the primary scenario that materially worsens external debt dynamics.
- Limit public external borrowing to preserve the low public external debt (17.2 percent of GDP) relative to international standards.
- Continue to monitor and address private sector rollover risks despite large share of intra-company lending, given potential market stress.
- Preserve reserve buffers and use FX intervention sparingly and only to smooth excess volatility of the lei.

*International Monetary Fund staff report (Romania): External debt trends, projections, stress tests, and external sector assessment (extract).*

### 2.      Apply a stressed DSTI limit to household loans and continue scaling back the Prima Casa

### 2.      Apply a stressed DSTI limit to household loans and continue scaling back the Prima Casa program.

### Macroprudential measures and bank policy
- 2. Apply a stressed DSTI limit to household loans and continue scaling back the Prima Casa program.  
  - Agencies: NBR, MoPF  
  - Time Frame: NT
- 3. Enforce a currency-differentiated LCR and NSFR for significant currencies.  
  - Agency: NBR  
  - Time Frame: NT
- 4. Introduce a carefully calibrated Systemic Risk Buffer to increase resilience against risks from large exposures to the sovereign.  
  - Agencies: NBR, MoPF, ASF  
  - Time Frame: NT
- 5. Ensure provisioning requirements for NBFLs tighten in line with the application of International Financial Reporting Standards (IFRS) 9 to banks.  
  - Agencies: NBR, MoPF  
  - Time Frame: NT

### Sectoral oversight — Bank Regulation and Supervision
- 6. Ensure consistency and objectivity in Supervisory Review and Evaluation Process (SREP) scores, findings and supervisory measures.  
  - Agency: NBR  
  - Time Frame: NT
- 7. Enhance supervisory tools by incorporating more forward-looking views (e.g., bottom up stress testing tools) and conducting more thematic reviews.  
  - Time Frame: MT
- 8. Strengthen bank corporate governance (number and profile of independent board members, content and periodicity of exchanges between the NBR and board members).  
  - Time Frame: NT
- 9. Review and amend the regulation not governed by EU harmonization (e.g., transactions with related parties) in a more prudent manner.  
  - Time Frame: NT

### Financial Market Infrastructures
- 10. Adopt the PFMI and formalize and strengthen cooperation between the NBR and the ASF for the supervision of the Bucharest Stock Exchange CSD.  
  - Agencies: NBR, ASF  
  - Time Frame: NT
- 11. Invest in more and more qualified IT staff, in particular in the area of cyber resilience, and implement a formal project management methodology.  
  - Agency: NBR  
  - Time Frame: I

### AML/CFT
- 12. Address the remaining gaps in the AML/CFT preventive framework, including with respect to PEPs, and entity transparency; assess and mitigate the ML/TF risks.  
  - Agencies: MoJ / MoAI  
  - Time Frame: I

### Crisis Management and Bank Resolution
- 13. Prepare a simulation exercise that includes all members of the macroprudential committee plus the FGDB.  
  - Agencies: all  
  - Time Frame: I
- 14. Seek an exemption from the Procurement law for bank resolution purposes.  
  - Agencies: NBR, MoPF  
  - Time Frame: MT
- 15. Include MoPF officers linked to bank resolution under personal legal protection provisions.  
  - Agency: MoPF  
  - Time Frame: MT
- 16. Ensure that Romania’s interests are addressed in recovery and resolution plans of Romanian subsidiaries of foreign banks.  
  - Agency: NBR  
  - Time Frame: NT
- 17. Diversify the investment policy of the FGDB, and establish operational procedures with the NBR that allows the FGDB to have accounts in the central bank and a repo line.  
  - Agencies: FGDB/NBR  
  - Time Frame: NT
- 18. Finalize and implement an ELA scheme and provisions for FX liquidity support.  
  - Agency: NBR  
  - Time Frame: NT

*Prepared by European Department — ROMANIA STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION (Informational annex content provided).*

### 1.      Recent data releases point to downside risks to growth, amidst rising

### 1.      Recent data releases point to downside risks to growth, amidst rising

### Growth
- Flash estimates: GDP growth decelerated on a seasonally adjusted basis to 4.2 percent y/y and 0 percent q/q in Q1 2018.
- March indicators: retail sales and industrial production weakened, consistent with the slowing.
- Other indicators remained buoyant: the trade deficit remained high, net wage and consumer credit maintained robust growth, and the unemployment rate continued to fall.
- Likely drivers of Q1 developments:
  - Private consumption was likely affected by uncertainty in employee incomes including due to the shift in social security contributions.
  - Industrial activity affected by broader slowdown in the Euro Area.
- Policy implications:
  - Downside risk to the 2018 growth outlook has increased.
  - Need for fiscal consolidation and monetary tightening remains given strong inflation pressures and the cyclical position of the economy.
  - If growth slows substantially further, the desirable pace of policy adjustments could be recalibrated.

### Inflation and monetary policy
- Headline inflation rose to 5.2 percent (y/y) in April 2018 from 5 percent (y/y) in March 2018.
- Core inflation was 3 percent (y/y) in both March and April 2018.
- National Bank of Romania (NBR) actions:
  - Raised policy rate on May 7 by 25 basis points to 2.5 percent.
  - Corresponding increases in deposit and lending facility rates to 1.5 percent and 3.5 percent, respectively.
  - Since mid-April 2018, NBR has undertaken liquidity absorption operations, leading to higher money market rates.
  - NBR raised the policy rate three times by 25 basis points in January, February, and May, up to 2.5 percent.
  - Deposit facility rate increased from 0.25 percent in September 2017 to 1.5 percent in May 2018.
- Monetary policy objective: bring annual inflation back in line with the target in the medium term while supporting sustainable growth; emphasis on balanced macroeconomic policy mix to avoid overburdening monetary policy.

### Fiscal developments and budget execution
- Preliminary budget execution through April 2018:
  - Fiscal balance: deficit of 0.7 percent of GDP in January–April 2018 versus a surplus of 0.2 percent of GDP in January–April 2017.
  - Revenues rose by some 0.2 percentage point of GDP (mostly due to higher social security contributions).
  - Spending rose by 1 percentage point of GDP due to:
    - One-off defense payment in February.
    - Wage hikes for health and education sectors in March.
    - Slightly higher interest expenditure.
- Government medium-term fiscal strategy:
  - ESA budget deficit projected to decrease from 2.95 percent of GDP in 2018 to 1.45 percent in 2021.
  - Medium-term objective for the structural deficit maintained at 1 percent.
- Policy measures and commitments:
  - Prioritize capital spending in the short term while keeping the deficit within EU fiscal rules.
  - Gradual fiscal consolidation starting in 2019, with most large-impact measures in place by end-2018.
  - Shifted payment of social security contributions from employers to employees to mitigate fiscal costs related to the Unified Wage Law.
  - Authorities committed to comply with EU fiscal rules and take compensatory measures if necessary.
- Public debt and debt sustainability:
  - Public debt-to-GDP ratio at only 36.8 percent in 2017 (calculated according to national legislation, without temporary financing).
  - DSA shows ratio would remain below 60 percent under all stress test scenarios.
  - Risks to debt sustainability assessed as low.

### Authorities’ outlook and growth drivers
- Recent performance and outlook:
  - Growth climbed to 6.9 percent in 2017.
  - Unemployment rate reached 4.5 percent in March 2018.
  - Private consumption was main driver of growth, boosted by fiscal measures to increase household income and reduce indirect taxation.
  - Recovery in private investment contributed to positive gross fixed capital formation in 2017; early 2018 saw rebound in non-residential and civil engineering construction.
  - Investment growth expected to accelerate over the medium term due to growth-friendly tax cuts, improved EU funds absorption, and credit expansion.
- External sector:
  - Exports growth accelerated in 2017 supported by FDI and stronger demand from European economies.
  - Imports grew faster due to rapid domestic absorption, pushing the current account deficit above 3 percent.
  - Over the medium term, current account deficit anticipated to remain at sustainable levels and financed primarily by non-debt-generating flows (FDI and EU funds).
  - Share of short-term debt in total external debt relatively low at 27 percent.
  - International reserves coverage adequate according to all reserve adequacy metrics.
  - Authorities monitor risks associated with sudden sharp exchange rate depreciation.

### Financial sector resilience and macroprudential measures
- Bank soundness improvements:
  - NPL ratio dropped from 21.5 percent in 2013 to close to 6.4 percent at end-2017.
  - Provisioning close to 65 percent.
  - Reduced dependence on parent funding from abroad and strengthened capital ratios increased resilience.
- Macroprudential framework and cooperation with FSAP:
  - NBR has developed experience in macroprudential policies; cooperation with FSAP mission teams produced valuable results.
  - Joint technical work included econometric modeling to evaluate maximum sustainable indebtedness at 50 percent for an individual.
  - Parallel solvency tests using different models produced similar results, suggesting NBR models are adequate.
  - NBR has analyzed extending debt-service-to-income ratios to mortgages to prevent excessive household indebtedness.
- Authorities’ view: recommendation on introducing capital buffer to address sovereign-bank nexus requires further review and impact analysis to avoid potential financial stability implications.

### Structural reforms and EU funds absorption
- Top priorities:
  - Reinvigorate public investment by increasing efficiency of fiscal management.
  - Improve EU funds absorption as critical source of financing investment.
- Revenue-side reforms:
  - Reform tax administration and build effective IT infrastructure for fiscal databases and revenue administration (inter alia with technical assistance from FAD).
- Expenditure-side reforms:
  - Set up a centralized procurement system.
  - Operationalize a Spending Review Department within the Ministry of Public Finance.
- Institutional and governance measures:
  - Authorities intend to propose a Fiscal Pact to promote fiscal stability and predictability.
  - Establishment of the Sovereign Fund for Development and Investment expected to give momentum to SOE reform.
  - Commitment to implement Law 111 on corporate governance and continue the fight against corruption.
- EU funds absorption progress:
  - Early absorption under 2014-2020 framework was weak, but progress made on designating managing authorities, compliance with ex-ante conditionality, and reducing administrative burden.
  - Authorities confident these measures will allow significant acceleration of absorption in coming years.

_Statement by Anthony De Lannoy, Executive Director for Romania and Cezar Botel, Advisor to the Executive Director; May 24, 2018; June 4, 2018._

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18148.pdf_