## 1romea2019001 ## Source details **Canonical URL:** [1romea2019001](https://www.imf.org/-/media/files/publications/cr/2019/1romea2019001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2019/1romea2019001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2019/1romea2019001.pdf.json) --- ### The Current Account Deterioration — Context and Drivers - Expansionary policies since 2016 added procyclical stimulus amid already brisk expansion, producing one of the fastest per capita GDP growth rates among new EU member states (NMS) since 2016 and strong employment. - Twin deficits deepened: the fiscal deficit approached "3 percent of GDP" and the current account deficit reached "4.5 percent of GDP" in 2018. - External deficit drivers: - Strong consumption and import-intensive growth. - Eroding competitiveness on the import side. - A global slowdown in 2018 weighing on exports. - Composition of spending deteriorated: investment shares in government and aggregate spending fell to multi-decade lows. - GEO 114 (GEO 114/2018) introduced sectoral measures and tax changes that caused economic dislocations, leu depreciation, and a stock market correction; subsequent revisions reduced some impacts but some measures remain. ### Recent Economic Developments (selected findings) - Growth and demand: - Real GDP growth: "4.1 percent" in 2018; accelerated to "5 percent year-on-year (y/y) in Q1 2019". - Output gap remained substantially positive in 2018. - Net wages rose by "16 percent y/y in January–April 2019". - Inventory and discrepancy term added about "2.5 percent of GDP" in 2018 and continued into Q1 2019. - Inflation: - Headline inflation within target band (2.5 ± 1 percent) by end-2018. - Headline inflation stayed above the target band since February 2019; core inflation exceeded "3 percent" since April 2019. - Fiscal: - 2018 headline cash deficit: "2.8 percent of GDP"; cyclically-adjusted deficit widened to "3.5 percent of GDP". - 2018 low-quality / one-off measures amounted to "0.6 percent of GDP". - 2018 accrual-based deficit (authorities): "3.0 percent of GDP". - Rising rigid spending (wages and social assistance) and falling investment share. - External: - Current account deficit: "4.5 percent of GDP" in 2018 (highest ratio in the EU). - Capital account inflows: around "1.2 percent of GDP" in 2018. - Net FDI (mostly reinvested earnings): around "2.4 percent of GDP" in 2018, financing about half of the current account deficit. - Staff external sector assessment (EBA-lite) indicates a current account gap in the range of "-1.5 to -3.5 percent of GDP". - Financial sector: - Stock of bank credit to private sector: "26 percent of GDP". - Share of FX credit: "34 percent". - NPL ratio: "5 percent" at end-2018 (from "22 percent" in 2013); EU average noted as "3.2 percent". ### Outlook and Key Macro Projections - Growth projections: - Growth projected around "4 percent in 2019" and to slow to "3 percent over the medium term". - Projections assume consumption-led activity and a current account deficit exceeding "5 percent of GDP in 2019-2020". - Macroeconomic table excerpts (selected exact figures) - Real GDP (yoy): 2015 "3.9", 2016 "4.8", 2017 "7.0", 2018 "4.1", 2019 "4.0", 2020 "3.5" - Output gap: 2015 "-2.5", 2016 "-1.3", 2017 "1.8", 2018 "2.1", 2019 "2.4", 2020 "2.1" - CPI inflation (yoy, eop): 2015 "-0.9", 2016 "-0.5", 2017 "3.3", 2018 "3.3", 2019 "4.5", 2020 "3.5" - Unemployment rate (average): 2015 "6.8", 2016 "5.9", 2017 "4.9", 2018 "4.2", 2019 "4.3", 2020 "4.6" - Current account balance: 2015 "-1.2", 2016 "-2.1", 2017 "-3.2", 2018 "-4.5", 2019 "-5.5", 2020 "-5.2" - Fiscal balance (cash): 2015 "-1.4", 2016 "-2.4", 2017 "-2.8", 2018 "-2.8", 2019 "-3.7", 2020 "-3.5" - Gross external debt: 2015 "57.4", 2016 "54.5", 2017 "49.8", 2018 "48.1", 2019 "47.3", 2020 "46.5" - Gross general government debt: 2015 "34.8", 2016 "34.8", 2017 "34.8", 2018 "36.6", 2019 "37.1" - Risks: - Domestic: policy shocks, fiscal stimulus during elections, backtracking on reforms, new pension law as significant medium-term fiscal risk. - External: sharper slowdown, global financial tightening, capital outflows. - Buffers: reserves and moderate government debt provide temporary cushion but may be insufficient if imbalances grow. ### Authorities’ Views - Authorities project GDP growth at "5.5 percent" for the year and exceeding "5 percent" in the medium term. - Authorities emphasized GEO 114 measures to alleviate construction workforce shortages and stimulate construction. - Authorities expressed reservations about the EBA-lite current account model fit and suggested the leu was broadly in line with fundamentals. ### Policy Prescription — Overall - Balanced macroeconomic policy mix: durable fiscal consolidation, greater exchange rate flexibility, tighter monetary stance, and resumed structural and governance reforms. ### Fiscal Policy — Staff Recommendations and Targets - Staff projects the 2019 budget (target deficit "2.8 percent of GDP") to result in an outturn of "3.7 percent of GDP" without additional measures. - Staff view 2019 revenues as overestimated by about "0.9 percent of GDP". - Staff recommends a credible commitment to reduce the deficit to "1.5 percent of GDP by 2022", transitioning toward the medium-term objective (MTO) of "1 percent of GDP". - Quality measures equivalent to about "1 percent of GDP" are estimated as needed to achieve the 2019 deficit target. ### Menu of Possible Consolidation Measures (Percent of GDP; cash basis) - Broadening of tax base and revenue efficiency gains (e.g., PIT and SSC for self-employed, microenterprises and construction, IT updating tax administration): 0.7 - Reducing bonuses for public employees (e.g., holiday vouchers): 0.6 - Enforcing the 10 percent buffer on current spending items 1/: 0.2 - Other measures (e.g, improved EU fund absorption, centralized procurement): 0.5 ### Fiscal Balance Targets (Percent of GDP; cash basis) - Budget deficit under current policies (IMF estimate): 2019 "-3.7" ; 2020 "-3.5" ; 2021 "-3.6-3.7" ; 2022 (not listed) - IMF-recommended budget: 2019 "-2.8" ; 2020 "-2.2" ; 2021 "-1.8" ; 2022 "-1.5" - Implied structural adjustment relative to previous year: 2019 "0.0" ; 2020 "0.6" ; 2021 "0.6" ; 2022 "0.5" - Additional measures needed: 2019 "0.9" ; 2020 "0.6" ; 2021 "0.4" ; 2022 "0.3" ### Revenue-side recommendations - Address tax efficiency gaps (estimated potential gains of "2½ percent of GDP"). - Strengthen revenue administration (ANAF): modernize IT infrastructure, adopt modern compliance risk management, improve large taxpayer administration, move toward more transparent and service-oriented model, and carefully manage envisaged restructuring. - Conduct a comprehensive review of the tax system to identify distortions and revenue potential. ### Expenditure-side recommendations - Bolster expenditure efficiency and transparency to reduce corruption vulnerability. - Rebalance budget structure by reducing the share of rigid spending (wages and pensions) to create room for investment. - Strengthen expenditure reviews and the procurement process. ### Monetary and Exchange Rate Policy - Further monetary tightening is needed to address rising inflation pressures. - Greater exchange rate flexibility recommended to preserve buffers and absorb external shocks. - Consumer Credit Reference Index (IRCC) (introduced in March, GEO 19) has shortcomings: backward-looking calculation, high volatility, and potential confusion with ROBOR. ### Financial Sector Resilience and Risks - Banking sector strong: profitable years, strong capital and liquidity, NPLs approaching EU average. - New bank tax creates uncertainty; could negatively affect cost of bank credit and distort allocation. - Recommendations: - Introduce a carefully calibrated systemic risk buffer. - Monitor bank exposure to the Romanian state (approached "20 percent of assets in 2018"). - Avoid incentive structures that increase sovereign exposure. - Continue strengthening the AML/CFT framework to meet FATF standards; strengthen asset declaration framework for senior officials. ### Structural Reforms to Stimulate Investment and Growth - Reform priorities: - Infrastructure: strengthen public investment management institutions; improve absorption of EU funds; use PPPs with careful value-for-money analysis; assess PPP desirability relative to other funding arrangements; strengthen governance of SOEs. - Governance and anti-corruption: renew anti-corruption efforts; recent judicial amendments criticized as potentially weakening anti-corruption capacity. - Minimum wages and labor market: minimum wage tripled over last 7 years to more than 40 percent of average wage; recommend setting minimum wage by a transparent mechanism reflecting labor productivity (SM/16/94). - Reverse trend of declining public investment and restart SOE reforms. ### Pension Law — Fiscal Risks and Recommended Reassessment - Parliament passed in June 2019 a new pension law, doubling pillar I pension benefits by 2022 if implemented as is. - Implemented without offsets, the law would add "3.2 percent of GDP" to total government expenditure in 2022. - DSA shows this could increase public debt in the medium term by 20 percentage points of GDP and nearly double gross financing needs to "14.4 percent of GDP" by 2024. - Replacement ratio projected to increase from "42 percent in 2018" to "64 percent by 2022". - Staff recommendation: Reconsider pace of implementation; conduct comprehensive review of the pension system to reflect fiscal space and reassess priorities. ### Box 2 — Pension Law Alternative DSA Scenario (illustrative assumptions and results) - Assumptions: - No offsetting policy measures adopted. - Financing costs increase by "300 basis points". - Scenario results: - Fiscal and current account deficits reach "8 percent of GDP" by 2022. - Public debt increases by "20 percentage points of GDP". - Public sector’s external financing needs triple by 2022. - Policy recommendation: Pace implementation and deepen fiscal reforms (revenue administration reform; review of tax system; more targeted social policies). ### Debt Sustainability, Financing, and Risks - Baseline DSA projections: - Public debt-to-GDP ratio projected to reach "43.1 percent" by 2024 (from "36.7 percent" current level in March 2019 tables). - Gross public financing needs: "7.5 percent of GDP in 2018", expected to increase to "8.4 percent in 2019" and remain above 8 percent by 2024. - Stress-test outcomes (selected): - Real GDP growth shock: debt reaches about "52 percent of GDP" and gross financing needs surge to "11.9 percent of GDP" in 2021. - Combined shock: debt reaches "57 percent of GDP" in 2024; gross financing needs average "11 percent" over 2021–2024. - Alternative pension-law scenario: public debt in 2024 reaching "59 percent of GDP" — a 16 percentage point increase relative to medium-term baseline; public gross financing needs jump to "14.4 percent of GDP". - Public gross financing needs (baseline projections): - 2017: "11.1 percent of GDP" - 2018: "7.6 percent of GDP" - 2019: "7.5 percent of GDP" - 2020: "8.4 percent of GDP" - 2021: "7.7 percent of GDP" - 2022: "7.5 percent of GDP" - 2023: "8.3 percent of GDP" - 2024: "7.9 percent of GDP" - Public sector baseline projections (selected indicators as of March 21, 2019): - Nominal gross public debt: 2017 "32.9 percent", 2018 "36.9 percent", 2019 "36.7 percent", 2020 "37.4 percent", 2021 "38.6 percent", 2022 "39.8 percent", 2023 "41.1 percent", 2024 "42.2 percent" - Real GDP growth (percent): 2017 "2.2", 2018 "7.0", 2019 "4.1", 2020 "4.0", 2021 "3.5", 2022 "3.0", 2023 "3.0", 2024 "3.0" - Effective interest rate (percent): 2017 "6.0", 2018 "3.6", projections 2019–2024 "4.3, 4.5, 4.3, 4.4, 4.3, 4.3, 4.2" (table entries) ### External Sector Assessment (Annex VI) - CA developments and model results (end-2018): - Actual CA: "4.5 percent of GDP" - Cyclical contributions: "-0.6 percent of GDP" - Cyclically adjusted CA: "-3.9 percent of GDP" - CA-Norm: "-2.5 percent of GDP" - Cyclically adjusted CA Norm: "-1.9 percent of GDP" - Multilaterally Consistent Cyclically adjusted CA: "-1.4 percent of GDP" - CA-Gap: "-2.5 percent of GDP" - REER Gap implied by CA model: "8 percent" - Staff’s CA-gap assessment: "-1½ to -3½ percent of GDP" - REER and competitiveness: - CPI-based REER appreciated by "2.8 percent" during 2018. - GDP-deflator based REER appreciated about "4.4 percent" in 2018. - IREER-based estimated REER gap implies an overvaluation of about "10 percent". - Capital and financial flows: - Capital account inflows: "1.2 percent of GDP" in 2018. - Net FDI inflows: "2.4 percent of GDP" in 2018 (covering about one half of CA deficit). - NIIP: "-43.6 percent of GDP" in 2018; projected to average around "-46 percent of GDP" over 2019–24. - Reserves: - Gross international reserves: "18 percent of GDP" in 2018; about "4.4 months" of prospective imports; about "42 percent of M2"; "89 percent of short-term debt (remaining maturity)". - Assessment: Reserves remain adequate overall. ### Market Developments and Growth-at-Risk (GaR) Findings - GEO 114 launch in mid-December 2018 triggered heightened policy uncertainty: largest one-day stock market drop (over "15 percent") since GFC; lei depreciated about "2 percent" in January 2019. - GaR model (partial-least-squares) calibrated for Romania: - External financial conditions have largest adverse growth impact in downside tails. - Domestic financial conditions have relatively small influence. - Historical and 1-year ahead projected distribution suggests a relatively high trend growth (close to "3.3 percent") conditional on recent factors. - Adverse-shock illustration: a VIX shock of ½ standard deviation would shift GDP growth distribution toward recessionary mode. ### Recent Policy and Data Updates (supplement dated August 20, 2019) - NBR kept policy rate at "2.5 percent" in July and August meetings; liquidity absorption operations kept money market rates close to policy rate. - Flash GDP growth: decelerated to "4.6 percent y/y in Q2 2019" (seasonally adjusted) from "4.9 percent y/y in Q1 2019". - Inflation: headline "4.1 percent y/y in July 2019"; core inflation above "3 percent" since April 2019. - First half 2019 current account deficit: about "2½ percent of GDP" (ratio of full-year GDP); widened by "38 percent" compared to same period in 2018. - Preliminary fiscal outturn through June 2019: fiscal deficit of "1.9 percent of GDP" (Jan–Jun 2019) vs "1.6 percent of GDP" in same period 2018. - Budget revision passed August 12, 2019: kept 2019 deficit target at about "2.8 percent of GDP" while raising revenues and expenditures; staff views revenues as overestimated. ### Implementation Status and Technical Assistance - Mixed implementation of prior Article IV recommendations: - Monetary tightening: implemented. - Fiscal adjustment and quality measures: not implemented / limited progress. - Tax administration modernization and EU funds absorption: limited progress. - Data and surveillance: national accounts use ESA 2010; large inventory contributions introduce statistical uncertainty. Romania subscriber to SDDS since May 4, 2005. - Technical assistance noted across tax administration, tax policy, public financial management, financial sector and monetary policy, and FSAP follow-ups. ### Staff Appraisal — Key Conclusions and Priority Recommendations - Romania among fastest growing in EU but imbalances widened (twin deficits and inflation pressures). - Near-term: start consolidation by meeting this year’s deficit target with quality measures; staff estimates additional measures of almost "1 percent of GDP" needed to bring fiscal deficit to budget law’s target. - Medium-term: durable fiscal consolidation toward MTO ("1 percent of GDP"), modernize revenue administration, improve expenditure efficiency and transparency, reverse decline in public investment. - Pension law: comprehensive review required; if implemented as is, it would undermine medium-term fiscal sustainability. - Financial sector: continue regulatory progress, monitor sovereign-bank nexus, implement AML/CFT legislation robustly. - Structural reforms: increase public investment, restart SOE reforms, moderate minimum wage hikes and link to productivity, renew anti-corruption efforts. - Recommendation: hold next Article IV consultation on standard 12-month cycle. *Source: IMF staff, "The Current Account Deterioration" (chapter from Romania country report).* ### 1. The Current Account Deterioration ____________________________________________________________ 17 ### 1. The Current Account Deterioration ____________________________________________________________ 17 ### Context and Drivers of the Deterioration - Expansionary policies since 2016 added procyclical stimulus amid already brisk expansion, producing one of the fastest per capita GDP growth rates among new EU member states (NMS) since 2016 and strong employment. - Twin deficits deepened: the fiscal deficit approached "3 percent of GDP" and the current account deficit reached "4.5 percent of GDP" in 2018. - The external deficit was driven by: - Strong consumption and import-intensive growth. - Eroding competitiveness on the import side. - A global slowdown in 2018 weighing on exports. - Composition of spending deteriorated: investment shares in government and aggregate spending fell to multi-decade lows, constraining sustainable long-term growth. - Political developments and an intense election cycle (three elections: 2019 presidential (end-year); 2020 local government (mid-year) and parliamentary (end-year)) could weaken incentives for fiscal moderation and structural/governance reforms. - GEO 114 (General Emergency Ordinance 114/2018) introduced sectoral measures and tax changes that caused economic dislocations, leu depreciation, and a stock market correction; revisions reduced some impacts but some measures remain that could hinder financial market development and investment. ### Recent Economic Developments (selected findings) - Growth and demand: - Real GDP growth: "4.1 percent" in 2018; accelerated to "5 percent year-on-year (y/y) in Q1 2019", led by consumption and inventory accumulation. - Output gap remained substantially positive in 2018. - Net wages rose by "16 percent y/y in January–April 2019". - Large inventory contribution and a sizable discrepancy term added about "2.5 percent of GDP" in 2018 and continued into Q1 2019, creating statistical uncertainty on growth. - Inflation: - Headline inflation within target band (2.5 ± 1 percent) by end-2018. - Since early 2019 elevated domestic demand, currency depreciation and GEO 114-related sectoral pricing disruptions increased inflation pressures; headline inflation stayed above the target band since February 2019. - Core inflation exceeded "3 percent" since April 2019. - Fiscal: - 2018 headline cash deficit: "2.8 percent of GDP"; cyclically-adjusted deficit widened to "3.5 percent of GDP". - 2018 year-end low-quality / one-off measures amounted to "0.6 percent of GDP". - 2018 accrual-based deficit calculated by authorities at "3.0 percent of GDP" (EU Excessive Deficit Procedure ceiling). - Expenditure composition: rising rigid spending (wages and social assistance) and falling investment share. - External: - Current account deficit: "4.5 percent of GDP" in 2018 (highest ratio in the EU). - Principal driver: deterioration in merchandise trade balance—import-intensive growth and slower exports of goods and services. - Surge in trade deficit for consumer goods (durables, non-durables, semi-durables and food). - Capital account inflows around "1.2 percent of GDP" in 2018 (low absorption of EU funds). - Net FDI (mostly reinvested earnings) around "2.4 percent of GDP" in 2018, financing about half of the current account deficit. - Staff external sector assessment (EBA-lite) indicates a current account gap in the range of "-1.5 to -3.5 percent of GDP". - Financial sector: - Bank credit growth strengthened but lagged GDP growth; stock of bank credit to private sector at "26 percent of GDP". - Share of FX credit at "34 percent". - NPL ratio fell to "5 percent" at end-2018 (from "22 percent" in 2013); EU average noted as "3.2 percent". - House prices growing more subdued than comparator countries. ### Outlook and Risks - Growth projections: - Growth projected to remain at around "4 percent in 2019" and to slow to "3 percent over the medium term". - Projections assume consumption-led activity, elevated inflation, and a current account deficit exceeding "5 percent of GDP in 2019-2020". - Projections assume limited fiscal stimulus after the 2019–2020 elections and some rein in of external deficits via weakening growth. - Key numbers from macro outlook table excerpt: - Real GDP (yoy): 2015 "3.9", 2016 "4.8", 2017 "7.0", 2018 "4.1", 2019 "4.0", 2020 "3.5" - Output gap: 2015 "-2.5", 2016 "-1.3", 2017 "1.8", 2018 "2.1", 2019 "2.4", 2020 "2.1" - CPI inflation (yoy, eop): 2015 "-0.9", 2016 "-0.5", 2017 "3.3", 2018 "3.3", 2019 "4.5", 2020 "3.5" - Unemployment rate (average): 2015 "6.8", 2016 "5.9", 2017 "4.9", 2018 "4.2", 2019 "4.3", 2020 "4.6" - Current account balance: 2015 "-1.2", 2016 "-2.1", 2017 "-3.2", 2018 "-4.5", 2019 "-5.5", 2020 "-5.2" - Fiscal balance (cash): 2015 "-1.4", 2016 "-2.4", 2017 "-2.8", 2018 "-2.8", 2019 "-3.7", 2020 "-3.5" - Gross external debt: 2015 "57.4", 2016 "54.5", 2017 "49.8", 2018 "48.1", 2019 "47.3", 2020 "46.5" - Gross general government debt (percent of GDP): 2015 "34.8", 2016 "34.8", 2017 "34.8", 2018 "36.6", 2019 "37.1" - Risks (tilted to the downside and sizable): - Domestic risks: further vulnerability from policy shocks, fiscal stimulus during election cycle, backtracking on structural policies, and the new pension law posing a significant medium-term fiscal risk. - External risks: sharper-than-expected external slowdown worsening the current account and financing pressures; sharp global financial tightening leading to capital outflows and higher borrowing costs. - Buffers: reserves and moderate government debt could provide temporary cushion but may be insufficient if imbalances continue to grow. ### Authorities’ Views - Authorities more optimistic: project GDP growth at "5.5 percent" for the year and exceeding "5 percent" in the medium term, citing Romania’s history of high growth and higher estimates of potential growth. - Authorities emphasized GEO 114 measures to alleviate construction workforce shortages and stimulate construction. - Authorities reaffirmed commitment to the EU fiscal framework and noted revisions to GEO 114 reflecting business concerns. - Authorities expressed reservations about the EBA-lite current account model fit and suggested the leu was broadly in line with fundamentals. ### Policy Discussions and Recommendations - Overall policy prescription: a balanced macroeconomic policy mix built on durable fiscal consolidation, greater exchange rate flexibility, tighter monetary stance, and resumed structural and governance reforms. - Fiscal stance: - Staff projects the 2019 budget (target deficit "2.8 percent of GDP") to result in an outturn of "3.7 percent of GDP" without additional measures. - Staff view revenues for 2019 as overestimated by about "0.9 percent of GDP". - Achieving the authorities’ 2019 target of "2.8 percent of GDP" would entail a marginally negative fiscal impulse relative to 2018 and help curb twin deficits. - Staff recommends a credible commitment to reduce the deficit to "1.5 percent of GDP by 2022", transitioning toward the medium-term objective (MTO) of "1 percent of GDP". - Quality measures equivalent to about "1 percent of GDP" are estimated as needed to achieve the 2019 deficit target. - Recommended fiscal reforms and quality measures: - Revenues: - Address tax efficiency gaps (estimated potential gains of "2½ percent of GDP"). - Strengthen revenue administration (ANAF): modernize IT infrastructure, adopt modern compliance risk management, improve large taxpayer administration, move toward more transparent and service-oriented model, and carefully manage envisaged restructuring (split of customs and tax administration). - Conduct a comprehensive review of the tax system to identify distortions and revenue potential. - Expenditures: - Bolster expenditure efficiency and transparency to reduce corruption vulnerability. - Rebalance budget structure by reducing the share of rigid spending (wages and pensions) to create room for investment. - Strengthen expenditure reviews and the procurement process. - Monetary and exchange rate policy: - Further monetary tightening is needed to address rising inflation pressures. - Greater exchange rate flexibility is recommended to preserve buffers and absorb external shocks. - Structural reforms: - Resume structural and governance reforms to boost growth potential and improve competitiveness. - Predictability of policy and resumed reforms would help re-orient the economy toward investment and sustainable income convergence. *Source: IMF staff, "The Current Account Deterioration" (chapter from Romania country report). * ### 17. The new pension law calls for a reassessment. The parliament passed in June 2019 a new ### 17. The new pension law calls for a reassessment. ### Pension law impact and fiscal risks - Parliament passed in June 2019 a new pension law, which entails doubling pillar I pension benefits by 2022. - Implemented as is (with no offsetting measures), the new law would increase pension spending in several steps and add 3.2 percent of GDP to the total government expenditure in 2022 (text table). - Debt sustainability analysis (DSA) shows that this could increase public debt in the medium term by 20 percentage points of GDP and nearly double gross financing needs to 14.4 percent of GDP by 2024 (Annex V and Box 2). - Higher pension spending would further worsen the budget structure and constrain resources available for public investment and other social spending. - Recommendation: Reconsider the pace of implementation of the law (in accordance with the clause subjecting the benefit increases to fiscal space) and conduct a comprehensive review of the pension system, last majorly reformed in 2010. - Review objective: Reflect available fiscal space and reassess the balance among social needs, equitable distribution and competing budgetary priorities (including spending on youth, current workers, and future productive investment). - Staff’s baseline scenario assessment: Romania is assessed to have fiscal space at risk. - Key drivers of this assessment are (i) the concern over the continued increase in public debt levels in the medium term in the staff’s baseline projection scenario and (ii) Romania’s persistently elevated sovereign interest rate spreads relative to regional peers. ### Fiscal outlook and staff recommendation - Under the baseline scenario staff estimates that the deficit will reach 3.7 percent of GDP in 2019. - Public debt would continue to increase in the medium term under the baseline. - Staff’s recommended fiscal consolidation: - Withdraw fiscal stimulus in a cyclical upturn, including a marginally negative fiscal impulse in 2019. - Transition Romania towards its medium-term fiscal objective. - Implement consolidation through high-quality measures centered on: - Reduction of preferential sectoral tax treatments, - Improvements in revenue efficiency, - Moderation in growth in the public wage bill. ### Menu of possible measures for fiscal consolidation (Percent of GDP; cash basis) - Broadening of tax base and revenue efficiency gains (e.g., PIT and SSC for self-employed, microenterprises and construction, IT updating tax administration): 0.7 - Reducing bonuses for public employees (e.g., holiday vouchers): 0.6 - Enforcing the 10 percent buffer on current spending items 1/: 0.2 - Other measures (e.g, improved EU fund absorption, centralized procurement): 0.5 - Source note: Sources: Romanian authorities and IMF staff calculations. - 1/ Proposed measure excludes health sector and central government investment spending. Transfers are not subject to the buffer. ### Fiscal balance targets (Percent of GDP; cash basis) - 2019 2020 2021 2022 - Budget deficit under current policies (IMF estimate): -3.7 -3.5 -3.6-3.7 - IMF-recommended budget: -2.8 -2.2 -1.8 -1.5 - Implied structural adjustment relative to previous year: 0.0 0.6 0.6 0.5 - Additional measures needed: 0.9 0.6 0.4 0.3 - Note: The line "Additional measures needed" indicates the additional year-on-year measures needed to bring the deficit from the "Budget deficit under current policies" to the "IMF-recommended budget." ### Monetary policy, exchange rate, and inflation - Monetary policy needs further tightening. - Inflation pressure drivers: sizable positive output gap, strong wage increases, fiscal stimulus, and nominal exchange rate depreciation thus far. - Staff projects inflation to stay above the NBR’s inflation target band by end-2019 and return to the target band in 2020, assuming significant monetary tightening (involving policy rate hikes) in the near term. - Tight liquidity management will continue to help monetary management and mitigate FX pressures. - Recommendation: Greater exchange rate flexibility and limited interventions to smooth excessive volatility of the leu to preserve buffers and absorb shocks. - The Consumer Credit Reference Index (IRCC), introduced in March (GEO 19), has shortcomings: backward-looking calculation, high volatility (driven by liquidity), and potential confusion from parallel use of IRCC for new loans and ROBOR for existing loans. - Authorities’ stance: NBR committed to rein in inflation, continue strict liquidity management, and acknowledged need for somewhat greater exchange rate flexibility; noted IRCC may complicate monetary policy though too early to assess full consequences. ### Financial sector resilience and risks - Banking sector performance is strong: several profitable years, strong capital and liquidity positions, non-performing loans approaching the EU average. - New bank tax creates uncertainty; could negatively affect cost of bank credit and distort allocation if linked to performance targets. - Recent policy uncertainty and IRCC introduction could hinder financial sector development. - Progress on FSAP recommendations: majority fully or partially implemented (Annex VII); areas lacking progress include scaling back the Prima Casa program (recently expanded). - Concerns and recommendations: - Introduce a carefully calibrated systemic risk buffer to increase resilience under high sovereign exposure. - Monitor bank exposure to the Romanian state (approached 20 percent of assets in 2018). - Avoid incentive structures (e.g., exemption of government bond holdings from the new bank tax) that could increase sovereign exposure. - Continue strengthening the AML/CFT framework in compliance with FATF standards (comprehensive assessment of ML/TF risks, customer due diligence for politically exposed persons, enhancing entity transparency) and the asset declaration framework for senior officials. - Authorities’ views: Broad agreement with staff’s financial sector assessment; NBR noted good progress on many FSAP recommendations, shared concerns over the sovereign-bank nexus, and are discussing a systemic risk buffer; enacted new AML/CFT law in July 2019. ### Structural reforms to stimulate investment and growth - Progress stalled or reversed in some cases; gaps relative to regional peers in quality of infrastructure and control of corruption have not narrowed since around 2015. - Decline in share of public investment in government spending contributed to infrastructure gaps, harming competitiveness, FDI and growth potential. - Reform priorities: - Infrastructure: Strengthen public investment management institutions; improve absorption of EU funds; use PPPs with careful value-for-money analysis and strengthened administrative capacity for evaluating fiscal risks; assess PPP desirability relative to other funding arrangements such as EU funds; strengthen governance of SOEs. - Governance and anti-corruption: Renew anti-corruption efforts to improve government revenue, spending efficiency, competitiveness, and reduce emigration of high-skilled workers; recent amendments to justice laws and initiatives to amend criminal codes have been criticized as potentially weakening anti-corruption capacity. - Minimum wages and labor market: Continued wage growth exceeding productivity harms competitiveness; the minimum wage has tripled over the last 7 years to more than 40 percent of the average wage; recommendation to set the minimum wage by a transparent and objective mechanism that reflects gains in labor productivity (SM/16/94). - Authorities’ views: Agreed on infrastructure priority and bottlenecks; argued construction activity was stimulated by GEO 114 and PPPs are alternative funding; did not commit to a systematic mechanism linking minimum wage to productivity; sovereign wealth fund no longer pursued; will not pursue further judicial system initiatives and will continue efforts to exit the EU’s Cooperation and Verification Mechanism. ### Staff appraisal — key conclusions and recommendations - Romania is among the fastest growing countries in the EU, but imbalances have widened (twin deficits and inflationary pressures). - A correction in the course of policies is needed to sustain convergence and reduce setback risk. - Policy mix: - Durable fiscal consolidation toward medium-term objectives to alleviate domestic inflation pressures and reduce required monetary tightening. - Monetary tightening and greater exchange rate flexibility to rein in inflation and absorb shocks. - Renewed structural reforms to facilitate investment. - Near-term fiscal action: Start consolidation by meeting this year’s deficit target with quality measures; staff estimates additional revenue and expenditure measures of almost 1 percent of GDP would be needed to bring this year’s fiscal deficit to the budget law’s target. - Medium-term fiscal action: Sustained revenue and expenditure reforms — modernize revenue administration (upgrade IT systems, improve compliance risk management), improve expenditure efficiency and transparency (strengthen expenditure reviews and procurement), and reverse the trend of declining public investment. - The new pension law, if implemented as is, would undermine medium-term fiscal sustainability and should be subjected to a comprehensive review balancing social and equity needs and fiscal costs. - Banking sector: Continue progress on financial regulation, monitor bank sovereign exposure, and robustly implement new AML/CFT legislation. - Structural reforms: Increase public investment rate from the current multi-decade low, restart SOE reforms, moderate minimum wage hikes and link to objective productivity criteria, renew fight against corruption. - Recommended to hold the next Article IV consultation on the standard 12-month cycle. *IMF staff assessment as presented in the source content.* ### Box 1. The Current Account Deterioration (concluded) ### Box 1. The Current Account Deterioration (concluded) ### Saving–Investment and Sectoral Drivers - Both private and public sectors contributed to the imbalance in 2014–2018, contrasting with the pre-2007 episode when the private sector was the sole driver. - Booming economic activity coincided with declining rates of both investment and savings, indicating consumption-driven expansion. - Savings declined faster than investment in the recent episode, widening the current account deficit; by contrast, pre-2007 the current account deficit widened because investment increased faster than savings. ### Changes in Current Account by Components (in percent of GDP) - Periods compared: - 2004‐2007 ΔCA: -6.0 - 2014‐2018 ΔCA: -3.8 - Decompositions: - ΔCA = ΔCA_Gov. - ΔCA_Private - ΔCA_Gov.: 2004‐2007 = 0.3 ; 2014‐2018 = -1.2 - ΔCA_Private: 2004‐2007 = -6.3 ; 2014‐2018 = -2.7 - ΔCA = ΔS - ΔI - ΔS: 2004‐2007 = 1.1 ; 2014‐2018 = -4.4 - ΔI: 2004‐2007 = 7.1 ; 2014‐2018 = -0.6 *Source: Eurostat and IMF staff calculations.* --- ### Box 2. Potential Consequences of the New Pension Law ### Fiscal and External Impact Summary - The new law will double the pillar I pension benefits by 2022 if implemented as is without offsetting policy measures. - Additional fiscal expenditures associated with the law: 3.2 percent of GDP by 2022 (compared to previous law). - Replacement ratio projected to increase from 42 percent in 2018 to 64 percent by 2022. - The new law would narrow the poverty risk gap for the elderly (highest in the EU based on 2017 estimates) but have no effect on the even higher poverty risk gap for population aged 18-64. - The government has yet to explain how the budget will accommodate the additional expenditures, despite a clause in the law emphasizing the importance of fiscal space. ### Illustrative Medium-Term Scenario Assumptions - Scenario elaborates on an alternative DSA scenario (Annex V) and assumes no offsetting policy measures are adopted. - Added pension expenditures boost aggregate demand but worsen economic sentiment as macroeconomic imbalances deteriorate. - Worsening sentiment and rapidly increasing external financing needs assumed to increase financing costs by 300 basis points. - Caveats: - Scenario does not incorporate any restraint from the EU’s Excessive Deficit Procedure if the fiscal deficit exceeds 3 percent of GDP. - Scenario traces first-round macroeconomic consequences and does not consider the possibility of more adverse market reactions (e.g., sovereign credit rating downgrade) and deeper economic dislocations. ### Scenario Results and Risks - Romania’s fiscal and current account deficits would both reach 8 percent of GDP by 2022. - Public debt would increase by 20 percentage points of GDP (Annex V). - External debt would also increase significantly; additional expenditures would predominantly need to be financed in external markets (given already high domestic bank exposures; Annex II), tripling public sector’s external financing needs by 2022. - Rising financing needs could trigger more adverse market reactions than the 300 basis-point increase assumed. - Increasing reliance on external financing would raise the foreign currency share of public debt and heighten exposure to exchange rate risk. ### Policy Recommendations - Authorities need to reassess implementation of the new pension law to ensure fiscal and external sustainability. - Without additional fiscal measures, the new law endangers medium-term fiscal sustainability and prolongs policy uncertainty with adverse effects on economic activity and investment. - Implementation of the new law can be paced to limit negative impacts on medium-term fiscal and external imbalances. - Redoubling fiscal reform efforts, along the lines of staff recommendations, would help provide fiscal space. In particular: - A comprehensive reform of revenue administration. - A review of the tax system to significantly raise fiscal revenues over the medium term (CR/18/149). - More targeted social policies could help alleviate poverty risks for the elderly and the rest of the population. --- ### Annex I. Summary and Evolution of December 2018 GEO 114 Policy Measures ### General Assessment - The December 2018 package (GEO 114/2018) surprised markets due to several drastic clauses and uncertainty on final implementation. - The announced measures were modified upon adoption, with extensive additional modifications in March 2019 (GEO 19/2019) and again in May 2019; further modifications look possible. - While the package can generate some additional fiscal revenue, it is likely to have significant negative impact, especially considering the surprise effect on predictability of the business environment and legislative stability. - The package contains many measures that distort markets, including differentiated sectoral treatments without a clear economic rationale; some measures potentially violate EU competition rules. ### Selected Measures and Revisions (highlights) - Sectoral tax on bank assets (initial design linked to ROBOR tiers): - Original: 0% for ROBOR up to 2% ; 0.1% per quarter for 2-2.5% ROBOR ; 0.2% per quarter for 2.5-3% ROBOR ; 0.3% per quarter for 3-3.5% ROBOR ; 0.4% per quarter for 3.5-4% ROBOR ; 0.5% per quarter for ROBOR above 4%. - March 2019 revision: de-linked from ROBOR; 0.4% of assets per year for banks with market share of 1% or more; 0.2% of assets per year for banks with market share of less than 1%; tax rate reduced depending on credit growth relative to preset target (2019 target for credit growth is 8%); tax rate reduced if interest margin is reduced relative to a benchmark margin (2019 target for cut in interest margin is 8% from a benchmark interest margin of 4 percentage points); loss making banks not subject to the tax; effectively applied only to credit to the private non-financial sector (government debt securities, loans to credit institutions and several other asset types are exempt). - May 2, 2019 additional revision: For new loans ROBOR replaced with interbank transactions-based index (IRCC), based on average inter-banking transaction rates two quarters earlier; existing loans not affected. - Sectoral turnover tax on energy and telecommunications: - Original: Increased from 0.4 to 3% for telecoms; increased from 0.1 to 2% for energy. - March 2019 modification: Coal-fired electricity producers exempted from the 2% tax. - Temporary energy price caps: - Original: Duration of 3 years; for gas at the level of 68 lei/MWh (below market price of 90 lei/MWh at announcement); for electricity caps to be determined by energy regulator. - March 2019: Non-residential consumers excluded from price caps; implementation postponed from April 1st to May 1st because earlier implementation judged not technically feasible. - Changes to the 2nd pension pillar: - Original: Participants can opt out after minimum 5-year participation; very sizable (more than 10-fold) increase in minimum capital requirements for pension fund administrators; reduction in management fees from 2.5% to 1% of contributions. - Postponed until June 2019; May 31, 2019 revision reduced increase in minimum capital requirements from a 10-fold increase to a 10-15 percent increase; implementation postponed to end-June 2019. - Sectoral tax exemptions for construction: - Applied to firms with more than 80% of activities pertaining to construction; reduction or exemption from PIT and parts of employer/employee SSC (latter limited to 2019-2028); minimum wage hike in construction to 3000 RON/month (more than 40 percent higher than the statutory minimum wage). - No change; definition of activities benefitting from exemptions clarified and expanded. - Amendments to procurement framework: - Reduced and de-centralized external control (including for EU-funded contracts). - No change. --- ### Annex II. Potential Macroeconomic Vulnerabilities ### Overview - Romania’s relatively narrow financing base and higher vulnerabilities accumulated due to procyclical policies since 2015 raise risks of a hard landing in the event of an adverse external financing shock. - Market developments after December 2018 were a short-lived stress episode. ### Key Indicators and Concerns (selected exact figures) - Romania: Selected Indicators, 2018 vs. 2015 and 2008 - Current account balance, % of GDP: - 2018: -4.5 - 2015: -1.2 - 2008: -11.6 - Fiscal balance (cash), % of GDP: - 2018: -2.8 - structural fiscal balance, % of GDP: - 2018: -3.6 - 2015: -0.0 - 2008: -4.6 - Gross public debt, direct debt only, % of GDP: - 2018: 38.9 - 2015: 37.1 - 2008: 11.3 - External debt, % of GDP: - 2018: 48.1 - 2015: 57.4 - 2008: 51.8 - Private credit (%, yoy): - 2018: 8.0 - 2015: 3.0 - 2008: 33.7 - Gross international reserves, billion euros 1/: - 2018: 36.8 - 2015: 35.5 - 2008: 28.3 - months of next year GNFS imports: - 2018: 4.3 - 2015: 5.9 - 2008: 7.8 - share of short-term external debt (in percent) 2/: - 2018: 87.7 - 2015: 89.2 - 2008: 89.2 - Gross external financing requirement, billion euro 2/: - 2018: 48.1 - 2015: 35.1 - 2008: 34.4 - Gross fiscal financing requirement, % of GDP: - 2018: 7.7 - 2015: 15.5 - 2008: 8.6 - in euro billion equivalent: - 2018: 15.5 - 2015: 13.7 - 2008: 9.3 - Government debt held by non-official creditors, % of GDP: - 2018: 36.5 - 2015: 34.2 - 2008: 14.8 - of which: Eurobonds: - 2018: 11.8 - 2015: 10.5 - 2008: 1.6 - Non-residents holdings share of domestic government securities, % of total: - 2018: 20.2 - 2015: 17.6 - 2008: 6.8 3/ - Private loans as percent of deposits (%, end period): - 2018: 80.1 - 2015: 90.7 - 2008: 133.5 Notes in source: - 1/ Since 2011, includes fiscal buffer in FX built up towards four months of financing needs. - 2/ Partly reflects methodological changes that increased short-term corporate external debt beginning 2016. - 3/ Earliest reported share for December 31, 2009. ### Detailed Vulnerabilities - Although indicators look acceptable relative to other EU countries, detailed analysis reveals potential sources of concern, heightened by a weakening eurozone outlook that dominates Romania’s external trade and financial exposures. - Public debt ratio is relatively low but conceals vulnerabilities: - Nominal market borrowing in domestic currency bonds and Eurobonds has increased markedly. - Romania’s sovereign credit rating has not risen above borderline-investment grade in a decade after EU accession. - Current account deficit widened rapidly from near balance in 2014 to exceed 4 percent of GDP in 2018, crossing the EU macroeconomic imbalance procedure indicative threshold of 4 percent. - The deficit has mostly been financed with FDI and EU funds, which together have recently amounted to about 4 percent of GDP. - A deficit above 4 percent would likely require additional market financing, increasing sensitivity to global financial market conditions. - Structural fiscal deficit deteriorated to 3.6 percent of GDP in 2018 after reaching a fiscal deficit of 1 percent of GDP (Medium Term Objective) in 2015. - Reserve coverage is declining as imports have surged and external public debt service requirements are sizable (see Table 4: Gross External Financing Requirements). - Banking sector considerations: - Headline loan-to-deposit ratios appear comfortable, but the small financial sector has a high domestic sovereign exposure (20 percent of bank assets, highest in EU as noted in the 2018 FSAP), limiting room to further increase sovereign exposure. *Source: IMF staff calculations and country authorities.* ### 3. Following the launch of the fiscal policy package (GEO 114, Annex I) in mid-December ### 3. Following the launch of the fiscal policy package (GEO 114, Annex I) in mid-December ### Recent market developments - The fiscal policy package launched in mid-December 2018 initially appeared to potentially affect Romania’s external and fiscal financing bases, having been aimed at banks and pillar II pension managers (together holding about 65 percent of the government’s lei securities). It also appeared to be targeted at important FDI sectors (energy and telecoms). - Heightened policy uncertainty surrounding the implementation of these measures initially led to the largest one-day stock market drop (over 15 percent) since the GFC, followed by some recovery once the revision of the measures was indicated. - With signs of some financial outflows and sharply higher trade deficit in January 2019, the lei-euro exchange rate depreciated by about 2 percent in January. - Romania’s exchange rate and financial flow movement contrasted with a broadly favorable “risk-on” environment of portfolio inflows into emerging markets since Q4 2018. - Romania is classified as a Frontier equity market, limiting its foreign investor base. - The EMBI spreads for Romania have widened relative to CEE peers since 2017, with an additional widening since December 2018. - A major credit rating agency in March 2019 had signaled a possible downgrade to sovereign rating outlook, conditional on corrective actions for GEO 114, but subsequently kept the outlook after changes were made by end-March. - Government lei securities auctions underperformed in January-February 2019, with recovery from March. - Currency depreciation in January 2019 followed a period of stability relative to peers in 2018. - While still adequate, reserves levels deteriorated somewhat since early 2017, while imports continue rising. ### Growth-at-Risk (GaR) model: methodology, caveats, and results - Model and calibration: - The GaR uses a partial-least-squares version of the Fund’s Growth-At-Risk model (WP/19/36) customized and calibrated with Romania’s data. - Because of data limitations, the model is estimated for Romania starting from year 2000 (or in a few cases from 2008 onwards). The short sample period limits statistical accuracy and applicability of results for Romania. - The modelling does not factor in the availability of buffers (e.g., FX reserves and fiscal financing buffer). - Main regressors for four partitions: - (i) Domestic financial conditions: one-week and 3-month ROBOR, interest rate volatility and inflation. - (ii) Main trading partners’ macro conditions: Germany’s GDP growth and share of exports relative to its GDP, Romania import shares for Germany, France and Italy. - (iii) Euro area (EA) financial conditions: EA VIX, 1-week Euribor, EA inflation. - (iv) World financial conditions: VIX, CEE bond flows, oil prices and its implied volatility. - Key findings: - External financial conditions have by far the largest adverse growth impact in the downside tails of the distribution, especially under an external volatility shock (such as occurred during the GFC and the European crisis). - Domestic financial conditions have a relatively small influence, reflecting low domestic financial intermediation. - Trade partner growth has been a steady contributing factor to Romania’s growth since year 2000, reflecting Romania’s rising export market share especially in autos (Dacia and Ford FDI). - The historical distribution and 1-year ahead projected distribution of GDP growth suggest Romania has a relatively high trend growth (close to 3.3 percent) which could continue conditional on recent factors. - There is a non-negligible probability of a sharp growth deceleration in the event of an external financing shock. - Adverse-shock illustration: - A shock of the VIX by ½ standard deviation (levels similar to 2010 and briefly 2015) would shift the GDP growth distribution to one with a mode of virtually recessionary levels (relative to the original distribution). ### Risk Assessment Matrix (selected risks, likelihoods, impacts, and policy responses) - 1. Weaker-than-expected global growth, notably in Europe (short/medium term) — Relative Likelihood: High - Transmission: Significantly lower exports given Romania's trade integration with Europe; worsening CA deficit while imports are elevated on domestic demand stimulus. - Expected impact: Worsening CA deficit, harder external financing, higher portfolio outflows, weaker investment activity, slower growth, rise in unemployment, weaker fiscal revenues, increase in borrowing costs. - Policy response: Allow greater exchange rate flexibility; if medium-term inflation outlook remains contained, some monetary loosening could be undertaken; utilize some of fiscal financing buffer on a temporary basis; diversify export markets and products; improve business environment to attract new investments, including FDI. - 2. Rising protectionism and retreat from multilateralism (short/medium term) — Relative Likelihood: High/Medium - Transmission: Escalating and sustained trade actions (including auto tariffs) lower Romania's exports integrated into European automotive supply chains; lower FDI in affected sectors. - Expected impact: Decline in exports, worsening CA deficit, weaker investment activity, slower growth, rise in unemployment. - Policy response: Allow greater exchange rate flexibility; diversify export markets and products; improve business environment to attract FDI; strengthen multilateral and regional collaboration. - 3. Sharp tightening of global financial conditions, notably sustained rise in risk premium in reaction to concerns about a disorderly Brexit (short term) — Relative Likelihood: Medium - Transmission: Investors may sell Romanian financial assets after reassessment of risks; outflows from foreign holdings of government bonds and short-term debt; possible disruptions to UK-related trade flows (4% of direct exports); financial market volatility could lead to rapid rise in interest rates and currency depreciation. - Expected impact: Increase in borrowing costs, risk of exchange rate overshooting and financial instability, NPLs rise due to weakened repayment capacity of borrowers of lei and FX loans. - Policy response: Tighten monetary settings, allow greater exchange rate flexibility; utilize some of fiscal financing buffer on a temporary basis. - 4. Excessive fiscal relaxation and wage increases resulting in loss of fiscal credibility (short/medium term) — Relative Likelihood: High - Transmission and expected impact: Worsening market sentiment and fiscal financing challenges; Romania enters EU's Excessive Deficit Procedure; external competitiveness suffers; risk of credit rating downgrade; rapid deterioration in twin deficits; possible sovereign-bank nexus feedback loops; loss of external competitiveness from surging labor costs and higher unemployment in lower segments. - Policy response: Tighten monetary and fiscal policies to reduce aggregate demand within a prudent policy mix; implement wage and pension changes in line with fiscal space; tighten spending reviews and strengthen budget composition towards quality investment; raise revenues and tax administration efficiency; articulate medium-term fiscal framework with predictable policies and objective criteria (e.g., minimum wage increases tied to competitiveness/productivity gains). - 5. Slippages in macro-critical structural reforms and continued heightened policy uncertainty (short/medium term) — Relative Likelihood: High/Medium - Transmission and expected impact: Uncertainty about business environment; risk of credit rating downgrade and increased cost of capital; suppressed investment and delays in infrastructure upgrades; stagnant productivity growth and loss of competitiveness; new fiscal risks. - Policy response: Re-start structural reform process; reduce uncertainty associated with new policy initiatives by (i) developing, implementing and adhering to longer-term policy frameworks, (ii) conducting high-quiality prior impact assesments, (ii) seeking prior consultation with stakeholders and (iii), when advisable, allowing for transitional periods in policy implementation. ### Implementation of the 2018 Article IV Key Recommendations (selected) - Fiscal recommendations: - Bring the 2018 fiscal deficit below a cyclically neutral level: - Implementation status: Not implemented. The cyclically adjusted fiscal deficit widened further in 2018, with continued bias towards consumption, reflecting expenditure increases (mostly wages, and to a lesser extent interest costs and pensions) and lower personal income taxes, despite higher social security contributions (following a shift) and higher non-tax revenues. The current account deficit widened further. - Measures to lower the deficit should avoid further deterioration of the budget structure and protect capital spending: - Implementation status: Not implemented. The budget deficit target was met through one off or low-quality measures involving extraordinary SOE dividends, retrospective EU financing, postponed VAT refunds and deferment of some spending. Share of rigid items increased, while capital spending as a ratio of GDP remained close to the compressed level of 2017. - Improve fiscal policy efficiency by improving tax collection efficiency, including reforming tax administration for the VAT and operationalizing new IT infrastructure; bolster expenditure efficiency via expenditure reviews and centralized procurement; improve EU funds absorption: - Implementation status: Limited progress. Apart from electronic cash registers, limited reforms of tax administration were undertaken, and a longstanding IT modernization project was cancelled. Centralized procurement was launched but progress on spending reviews was modest, while absorption of new EU funds for infrastructure was weak. - Monetary and financial recommendations: - Continue tightening monetary policy to curb inflation and anchor expectations: - Implementation status: Implemented. The NBR raised its policy rate three times in H1 2018, and further tightened liquidity management. Inflation fell back to within the target band at end 2018. - Central bank independence and refrain from government-linked benchmarks that undermine monetary policy: - Implementation status: Partially implemented. NBR tightened monetary policy to achieve its inflation target, but the government introduced in December a bank asset tax linked to interbank rates, with the tax levels calibrated to a government-determined benchmark, potentially undermining monetary policy. - Address vulnerabilities from exposure of banks to the government and the real estate sector, and scale back the Prima Casa guarantee program: - Implementation status: Implemented/Substantial progress. The central bank introduced a debt-service-to-income limit on household loans effective January 2019. The government thus far did not scale back the Prima Casa program in 2019. - Avoid legislative initiatives that hamper financial intermediation and stability: - Implementation status: Limited progress. Three legislative initiatives that affected the banking sector were adopted by the parliament but struck down by the Constitutional Court in March 2019. In December 2018 government introduced a sizable asset tax on the banking sector (subsequently scaled back in March 2019). - Structural reforms: - Strengthen public investment management institutions; renew commitment to strong corporate governance for SOEs; ensure sovereign investment fund and development bank reflect international best practices; establish transparent minimum wage mechanism based on objective criteria: - Implementation status: Limited progress. EU funds absorption remained relatively low in 2018 for the programming period 2014-2020. Many SOEs in practice appear not to have applied corporate governance legislation (GEO 109) to their interim boards. Legal framework for the sovereign investment fund was established but lacked clarity in defining objectives, risks and investment strategy, with initial board exemptions from corporate governance legislation. Minimum wages were raised in early 2018 without reference to criteria. ### Debt Sustainability Analysis (DSA): baseline, scenarios, and projections - 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 43.1 percent by 2024 from the current level of 36.7 percent. - Gross public financing needs (7.5 percent of GDP in 2018) are expected to increase to 8.4 percent in 2019 and remain above 8 percent by 2024. - While the DSA suggests public debt is sustainable under various shocks, in the recession scenario debt reaches around 52 percent by 2024. - The combined macro-fiscal shock shifts the debt trajectory most significantly, pushing debt to 57 percent by 2024. - Exposure to international capital outflows continue to present a notable risk, with the associated debt profile vulnerability indicator exceeding the upper early warning benchmarks. - Comparison with previous assessment: - The baseline debt trajectory has increased relative to last year’s DSA. - The debt outturn for 2018 was marginally lower-than-expected, because the fiscal balance remained contained below 3 percent (outturn of 2.96 compared to 3.6 percent of GDP in 2018 DSA). - The medium-term trajectory for debt is higher due to: (i) higher projected deficits for 2019-2024 compared to 2018 DSA, and (ii) lower projected growth for 2020-23 compared to 2018 DSA. - Under the baseline scenario, the budget deficit is expected to exceed 3.5 percent over the period 2019-2023—without additional measures—thus violating the 3 percent rule under the Stability and Growth Pact. - The budget deficit is expected to peak in 2022 at 3.7 percent of GDP due to increasing pension expenditures and the peak of the EU financing cycle, and gradually decline thereafter. - Baseline and realism of projections: - Debt level: Under the baseline scenario, gross debt level (including guarantees) is projected to rise gradually over the medium term, reaching 43.1 percent in 2024. - Gross financing needs are projected to increase to 8.3 percent of GDP by 2022—from 7.5 percent in 2018—and stabilize thereafter. - Fiscal balance and adjustment: In the baseline projection, the budget deficit peaks in 2022 at 3.7 percent of GDP and declines to 3.3 percent of GDP in 2024. - The deterioration in the budget deficit in 2019 is mainly driven by the continued wage and pension increases. - Over the medium term, revenue and expenditure projections are driven by macroeconomic projections for key variables and the assumption that absorption of EU funds will gradually improve over the medium term. - Taking into account the distribution of fiscal adjustment episodes provided in the DSA template (Figure 2), the projected 3-year adjustment in the cyclically-adjusted primary balance (CAPB) of 0.5 percent of GDP indicates that there may be room for a greater adjustment in Romania. Similarly, the 3-year average level of the CAPB places Romania in lower end of the distribution. - Growth: The current real GDP growth projection of 4.0 percent for 2019 is significantly lower than the authorities’ forecast of 5.5 percent. - Reflecting the temporary nature of the fiscal impulse and slow progress in structural reforms, medium-term growth is expected to stabilize at 3.0 percent of GDP. - The recession scenario assumes a drop in real GDP growth to -0.9 percent in 2020 and 2021, with a sharp recovery thereafter. - Boom-bust analysis: Not triggered because the three-year cumulative change in the credit-to-GDP ratio does not exceed 15 percent in Romania and output gap has been positive for less than three years. *Source: 1romea2019001 - 3. Following the launch of the fiscal policy package (GEO 114, Annex I) in mid-December (PDF chapter/section).* ### 5. Maturity, rollover and other risks. To manage financing risk, the authorities maintain a ### 5. Maturity, rollover and other risks. To manage financing risk, the authorities maintain a ### Financing risk, maturity, and currency composition - The average maturity of government securities issued on the domestic market was 3.2 years at the end of 2018. - Foreign currency denominated debt accounts for about half of total public debt. - The authorities maintain a foreign currency financing buffer. - The authorities’ debt management strategy aims to issue longer-term securities and lengthen the yield curve to address rollover risks. - The new pension law presents a significant fiscal risk; an alternative scenario incorporating the fiscal impact of the new pension law shows: - Public debt in 2024 reaching 59 percent of GDP — a 16 percentage point increase relative to the medium-term baseline. - Public gross financing needs jump to 14.4 percent of GDP. - Public gross financing needs (baseline, Figure 4 / projection): - 2017: 11.1 percent of GDP - 2018: 7.6 percent of GDP - 2019: 7.5 percent of GDP - 2020: 8.4 percent of GDP - 2021: 7.7 percent of GDP - 2022: 7.5 percent of GDP - 2023: 8.3 percent of GDP - 2024: 7.9 percent of GDP ### Stochastic simulations and fan charts - Fan charts illustrate possible evolution of the debt ratio using symmetric and asymmetric distributions of risk. - Under the symmetric distribution, there is a high level of certainty that debt will remain below 60 percent of GDP (threshold under the Stability and Growth Pact) over the medium term. ### Stress tests — key scenarios and outcomes - Real GDP growth shock: - Debt ratio remains below 60 percent of GDP under all scenarios. - Under the real GDP growth shock, debt reaches about 52 percent of GDP and public gross financing needs surge to 11.9 percent of GDP in 2021. - Combined shock (largest effects of individual shocks on real GDP growth, inflation, primary balance, exchange rate and interest rate): - Debt would reach 57 percent of GDP in 2024 without showing signals of a declining trajectory. - Gross financing needs average at 11 percent over the 2021-2024 period. - Note on alternative pension-law scenario: assumes widening fiscal deficits trigger a 300 bp increase in financing costs and a zero net impact on GDP growth rates, as direct fiscal stimulus and worsening economic sentiment broadly offset. ### Public sector baseline projections (selected indicators, as of March 21, 2019) - Nominal gross public debt: - 2017: 32.9 percent of GDP - 2018: 36.9 percent of GDP - 2019: 36.7 percent of GDP - 2020: 37.4 percent of GDP - 2021: 38.6 percent of GDP - 2022: 39.8 percent of GDP - 2023: 41.1 percent of GDP - 2024: 42.2 percent of GDP - Primary balance (percent of GDP): - 2017: 2.3 (primary deficit labelled as 2.3) - 2018: 1.7 - 2019: 1.5 - 2020: 2.3 - 2021: 2.1 - 2022: 2.1 - 2023: 2.2 - 2024: 2.1 (projection shows primary deficit evolving; table lists primary deficit contributions and levels) - Real GDP growth (in percent): - 2017: 2.2 percent - 2018: 7.0 percent - 2019: 4.1 percent - 2020: 4.0 percent - 2021–2024: 3.5, 3.0, 3.0, 3.0 percent respectively (baseline) - Inflation (GDP deflator, in percent): - 2017: 4.6 percent - 2018: 4.7 percent - 2019: 5.9 percent - 2020–2024: 4.6, 3.1, 3.3, 3.4, 3.3, 3.0 percent (as tabulated) - Effective interest rate (in percent): - 2017: 6.0 percent - 2018: 3.6 percent - 2019–2024 projections: 4.3, 4.5, 4.3, 4.4, 4.3, 4.3, 4.2 (table entries) - Change in gross public sector debt (cumulative 2019–2024): 6.4 (cumulative change) - Identified debt-creating flows (cumulative 2019–2024): 7.1 ### Composition of public debt and alternative scenario assumptions (selected) - Composition by maturity (projection): - Share of short-term vs medium and long-term debt shown historically and projected through 2024 (figures in text). - Composition by currency (projection): - Local currency-denominated vs foreign currency-denominated debt shown historically and projected through 2024. - Alternative scenario assumptions (selected): - Baseline underlying assumptions (2019–2024): Real GDP growth 4.0, 3.5, 3.0, 3.0, 3.0, 3.0; Inflation 4.6, 3.1, 3.3, 3.4, 3.3, 3.0; Primary Balance -2.3, -2.1, -2.1, -2.2, -2.1, -1.8; Effective interest rate 4.5, 4.3, 4.4, 4.2, 4.3, 4.2. - New Pension Law scenario (2019–2024): Primary Balance -2.3, -2.8, -4.7, -5.8, -5.7, -5.5; Effective interest rate 4.5, 4.3, 4.7, 5.1, 5.7, 6.0. ### External debt trends, risks, and stress outcomes - Gross external debt: - Peaked in 2012 at 75.7 percent of GDP. - Declined to 48 percent of GDP in 2018. - Short-term debt accounted for 28 percent of total external debt in 2018 and is largely covered by inter-company lending. - Public external debt at 16.4 percent of GDP in 2018. - Baseline projections and medium term: - External debt expected to marginally decline to around 46 percent of GDP in 2025 under current policies. - Gross external financing needs expected to gradually decline but to stay above 20 percent of GDP. - Gross external financing needs (in percent of GDP, Table 1 projections): - 2018: 24.6 percent of GDP - 2019: 24.9 percent of GDP - 2020: 23.8 percent of GDP - 2021: 22.1 percent of GDP - 2022: 22.4 percent of GDP - 2023: 21.3 percent of GDP - 2024: 20.8 percent of GDP - Staff stress-test findings: - Debt stays close to the 2018 level under an interest rate shock. - Debt slightly increases in growth-rate and current account shock scenarios. - In a tailored combined shocks scenario (permanent ½ standard deviation shock to growth, current account and interest rate), external debt reaches 55 percent of GDP in 2024. - A stress scenario with a 30 percent depreciation indicates external debt would increase sharply to 69 percent of GDP in 2020 and hover around that level over the medium term. - External debt ratios and indicators (Table 1 selected entries): - External debt-to-exports ratio (in percent): 2014: 153.0; 2015: 140.0; 2016: 132.4; 2017: 120.0; 2018: 115.6; 2019: 110.4; 2020: 109.0; 2021: 108.6; 2022: 108.5; 2023: 109.0; 2024: 109.2. - Debt-stabilizing non-interest current account (percent of GDP): 0.9 (Table 1) *Source: IMF staff.* ### Annex VI. External Sector Assessment ### Annex VI. External Sector Assessment ### Current Account - Romania’s current account (CA) deficit surged to 4.5 percent of GDP in 2018 from 3.2 percent of GDP in 2017. - The CA deficit is expected to further deteriorate in 2019 and stay above 4 percent over the medium-term. - The deterioration reflects surging consumption imports fueled by strong wage growth over the last two years. - EBA-lite CA model results (end-2018): - Actual CA: 4.5 percent of GDP - Cyclical contributions (from model): -0.6 percent of GDP - Cyclically adjusted CA: -3.9 percent of GDP - CA-Norm: -2.5 percent of GDP - Cyclically adjusted CA Norm: -1.9 percent of GDP - Multilaterally Consistent Cyclically adjusted CA: -1.4 percent of GDP - CA-Gap: -2.5 percent of GDP - Policy gap (of which): 0.03 percent of GDP - Elasticity: -0.31 - REER Gap implied by CA model: 8 percent - CA-Fitted: -2.5 percent of GDP - Residual: 0.02 percent of GDP - Natural Disasters and Conflicts: 0.0 percent of GDP - The CA gap is only partly explained by policy gaps; domestic fiscal policy gap (2 percent of GDP in line with staff’s fiscal policy recommendations) contributes -0.86 percent of GDP to the CA gap but is largely offset by a similar policy gap of trading partners. - Negative gaps from fiscal policy and public health expenditure are offset by positive policy gaps from change in reserves and private sector credit. ### Real Exchange Rate - CPI-based real exchange rate (REER) appreciated by 2.8 percent during 2018, largely due to higher inflation than in trading partners. - GDP-deflator based REER appreciated by about 4.4 percent in 2018. - Unit labor cost (ULC) increased about 4 percent; ULC-based REER appreciated about 5 percent. - Export share increased from 0.35 in 2014 to 0.39 percent of total world exports in 2017; this increase largely due to exports of FDI enterprises integrated in global value chains and does not necessarily imply improved cost competitiveness. - Import increase as a share of GDP suggests a decline in competitiveness in the domestic market due to wage-driven cost pressures on domestic producers. - EBA-lite IREER model results (2018): - Ln(REER) Actual: 4.58 - Ln(REER) Fitted: 4.48 - Ln(REER) Norm: 4.48 - Residual: 0.10 - REER Gap: 10 percent - Policy Gap: 0.2 percent - Natural Disasters and Conflicts: 0.2 percent - Assessment: IREER-based estimated REER gap implies an overvaluation of about 10 percent, broadly consistent with CA-model based assessment. ### Capital and Financial Flows - Capital account recorded inflows of 1.2 percent of GDP in 2018, below the 5-year trend of 2 percent of GDP. - Net FDI inflows: 2.4 percent of GDP in 2018, the main contributor to financing the CA deficit, covering about one half of it. - A majority of FDI inflows are reinvested earnings and are expected to continue to play an important role over the medium-term. - Portfolio flows: 1 percent of GDP in 2018, slightly declined due to lower sovereign bond issuance. - No restrictions on the capital and financial account. - Assessment: - Capital account inflows may pick up with higher absorption of EU funds. - Prospects for new FDIs are unclear due to poor infrastructure, rising labor cost, and still high policy uncertainty. - Portfolio flows may pick up if authorities issue more Eurobonds instead of issuing bonds on the domestic market, though this could lead to higher spreads. ### External Balance Sheet - NIIP: -43.6 percent of GDP in 2018; improved over the last five years mostly from a decline in liabilities (other investment) as banks and companies deleveraged. - NIIP in nominal terms deteriorated by about 1 percent in 2018 as accumulation of liabilities slightly exceeded accumulation of assets. - By end-2018: - Direct investment: about 11 percent of gross assets and 56 percent of gross liabilities. - Portfolio investment: about 6 percent of gross assets and about 17 percent of gross liabilities. - Other investment liabilities (mostly loans to corporate sector and trade credits): 20 percent of GDP — could lead to liquidity problems in case of sudden tightening of financial conditions (partly offset by claims of Romanian corporate sectors toward non-residents). - Staff projection: NIIP expected to average around -46 percent of GDP over 2019–24. - Assessment: External balance sheet does not appear to be a major source of risk for external sustainability, but other investment liabilities pose liquidity risk. ### Reserves - Exchange rate regime: classified as floating in 2018. - Gross international reserves: - 18 percent of GDP in 2018 - Could cover about 4.4 months of prospective imports - About 42 percent of M2 - Reserves stood at 89 percent of short-term debt (remaining maturity) - Reserves declined marginally in nominal terms, about 1 percent relative to 2017. - Assessment: - Reserves remain adequate, exceeding thresholds for most metrics. - Reserves were above 150 percent of the reserve-adequacy metric developed by the Fund for emerging markets. - Reserves are above comfortable thresholds for most other metrics, except being 89 percent of short-term debt (at remaining maturity). ### Overall Assessment and Policy Recommendations - Staff’s overall assessment: Romania’s external position is weaker than implied by fundamentals and desirable policy settings. - Staff assesses: - Current account gap: -1½ to -3½ percent of GDP - REER overvaluation: 5-10 percent - To reduce the external imbalance, staff advises: - Durable fiscal consolidation - Greater exchange rate flexibility - Structural reforms to boost productivity and competitiveness *Source: IMF staff estimates and Annex VI. External Sector Assessment (Romania).* ### 18. Finalize and implement an ELA scheme and provisions for FX liquidity support. NBR NT Work in ### 18. Finalize and implement an ELA scheme and provisions for FX liquidity support. NBR NT Work in progress ### Recommendation, agencies, and timeframe - Recommendation: Finalize and implement an ELA scheme and provisions for FX liquidity support. - Agencies: ASF = Financial Services Authority; FGDB = Bank Deposit Guarantee Fund; MoPF = Ministry of Public Finance; NBR = National Bank of Romania. - Time frame definitions (as provided): - I (immediate) = within one year - NT (near term) = 1-3 years - MT (medium term) = 3-5 years - Status note: Refers to status or progress, as reported by the authorities. ### Recent macroeconomic developments (supplementary information) - Growth: - Flash estimates: GDP growth decelerated to 4.6 percent y/y in Q2 2019 (seasonally adjusted), down from 4.9 percent y/y in Q1 2019. - Sectoral: Industrial production and exports slowed; construction grew strongly; retail sales and consumer confidence were firm; net wages continued to rise rapidly; unemployment remained low. - Private consumption likely remained the main contributor to growth (GDP expenditure components not yet available). - Inflation: - Headline inflation: 4.1 percent y/y in July 2019, up from 3.8 percent y/y in June 2019; rise mainly due to higher food inflation. - Target band: 2.5 percent ± 1 percent. - Core inflation: Remained above 3 percent since April 2019, rising to 3.3 percent y/y in June and July 2019, indicating higher domestic-driven inflation pressures. - Current account: - First half of 2019 current account deficit: about 2½ percent of GDP (outturn for the first half year, as a ratio of full-year GDP). - Widened by 38 percent compared to the same period in 2018 (about 1¾ percent of GDP). - Financing: Share of FDI in the financing structure fell below half (about the share of FDI in 2018); portfolio bond inflows rose in recent months. - Fiscal/budget execution: - Preliminary outturn through June 2019: fiscal balance deficit of 1.9 percent of GDP in January–June 2019, compared to a deficit of 1.6 percent of GDP over the same period in 2018. - Revenues (with the exception of dividends) lagged expenditures; expenditures pushed up mainly by higher wage expenses. ### Budget revision and fiscal outlook - Budget revision passed August 12, 2019: - Kept the 2019 deficit target at about 2.8 percent of GDP. - Raised both revenue and expenditure while maintaining the GDP growth forecast at 5.5 percent. - Revenue increases based primarily on higher dividend collections, anticipated yield from a tax amnesty and tax debt restructuring program passed on August 5, and EU retrospective financing. - Expenditure increases primarily to accommodate higher spending by local governments. - Staff assessment: - Staff views revenues as overestimated and some expenditures underestimated. - High-quality measures are in urgent need for fiscal consolidation towards the budget target. ### Data, surveillance, and technical assistance context - Data adequacy: - General: Data provision is adequate for surveillance. - National accounts: Produced by INS using ESA 2010; large contribution from changes in inventories introduce statistical uncertainties (observed in 2018 and Q1 2019). Provisional and semi-final versions are disseminated. - Prices: CPI subject to standard annual reweighting and considered reliable. PPI covers domestic and export sectors; PPI weights revised every five years with revisions finalized three years after the new base year. - Labor market: Statistics broadly adequate; employment definition consistent with ESA 2010. - Public finances: Annual GFS data reported on an accrual basis derived from cash data; accrual data available quarterly three months after quarter end; EUR receives monthly cash budget execution data. - Monetary and financial statistics: NBR reports SRFs monthly for central bank and other depository corporations, quarterly for OFCs; reports key Financial Access Survey series and IRFCL Data Template. - FSIs: NBR reports all core and most encouraged FSIs for Deposit Takers quarterly; FSIs for NFCs reported with a long lag. - External sector statistics: NBR reports quarterly and annual BOP and IIP statistics; implemented BPM6 since September 2014; participates in CPIS and CDIS; reports IRFCL Data Template. - Standards and assessments: - Romania subscriber to SDDS since May 4, 2005. - Data ROSC published November 2001. - Technical assistance (selected focus areas and chronology): - Tax administration: Multiple missions 2012–2016 to strengthen ANAF, organizational reforms, compliance strategy, pilot structural compliance projects, training on payroll audit, high net wealth individual compliance. - Tax policy: Assistance on property tax, natural resource tax regime (September 2013, September 2014, June 2015). - Public financial management: Assistance on commitment control, fiscal reporting systems, fiscal transparency evaluation (March 2012–January 2015 and follow-ups through October 2016). - Financial sector and monetary policy: Missions on contingency planning, monetary policy framework assessment, achieving timely NPL write-off within IFRS (November 2012, October 2014, October 2013). - FSAP and ROSC: - Joint IMF-World Bank FSAP update mission: October 21–November 31, 2017 and January 11–23, 2018; FSSA discussed at the Board in June 2018. - Pilot IMF Fiscal Transparency Evaluation: February 2014; findings published March 2015. *Prepared by European Department; supplement dated August 20, 2019.* ### 3. The National Bank of Romania (NBR) kept its policy rate at 2.5 percent in its July and ### 1romea2019001 - 3. The National Bank of Romania (NBR) kept its policy rate at 2.5 percent in its July and ### Monetary policy and liquidity management - The NBR kept its policy rate at 2.5 percent in its July and August policy meetings. - The NBR has undertaken liquidity absorption operations, which have kept money market rates close to its policy rate. - Throughout 2018, the NBR raised the policy rate three times by 0.25 percentage points, up to 2.5 percent, while tightening liquidity in the banking system. - The NBR pursued active management of money market liquidity amid large swings in liquidity and strong autonomous factor impacts. - The NBR stressed commitment to continue strict liquidity management while considering greater exchange rate flexibility. - Monetary stance aims to bring annual inflation in line with the flat target of 2.5 percent ±1 percentage point variation band over the medium term, while remaining supportive of economic growth and safeguarding financial stability. - The NBR Board emphasized the importance of a coherent macroeconomic policy mix and structural reforms to safeguard macroeconomic stability and resilience. ### Economic growth, labor, and investment - 2018 economic growth reached 4.1 percent. - Per capita GDP recorded one of the fastest growth rates amongst new EU member states since 2016. - Unemployment rate dropped to 4.2, the lowest level in recent years. - The expansion in 2018 was primarily driven by private consumption supported by income policies. - Contribution of gross fixed capital formation to GDP growth in 2018 was negative (-3.2 percent). - Investment growth resumed in Q1 2019 due to a rise in construction works, contributing to an acceleration of economic growth to 5.0 percent from 4.1 percent in Q4 2018. - Authorities project growth of 5.5 percent in 2019 and 5 percent over the medium term (authorities’ projections, faster than staff’s baseline). ### Inflation dynamics - During the first three quarters of 2018 the inflation rate ran above the upper bound of the ±1 percentage point variation band of the 2.5 percent flat target due to excess aggregate demand, rapid unit wage cost dynamics, and supply shocks. - At the end of 2018, annual CPI inflation stood at 3.3 percent, within the target band. - In Q1 2019, higher domestic demand, currency depreciation, and price disruptions associated with GEO 114/2018 pushed inflation above the target band. ### External position and financing - Current account widened in 2018 by 1.3 percent of GDP to 4.5 percent of GDP, driven by strong import growth, buoyant consumption, and slower export growth. - Net export contribution to GDP growth in 2018 was -1.7 percent, the lowest in five years. - The deficit is anticipated to remain at sustainable levels over the medium term and continue to be financed mainly from non-debt-generating flows (FDI and EU funds). - Gross external debt fell to 48 percent of GDP in 2018 from a peak of 75.7 percent of GDP in 2012. - The share of short-term debt in total external debt remained low (28 percent of GDP). - International reserves are adequate, exceeding thresholds for most metrics. - Authorities note risks from a sharper-than-expected external slowdown and adverse global financial conditions and continue to monitor these risks. ### Public finances and fiscal policy - Budget deficit reached 3 percent of GDP in 2018. - Structural deficit rose to 3.0 percent (compared with the 1 percent-of-GDP target in the Stability and Growth Pact). - Convergence Program 2019-2022 foresees the ESA budget deficit gradually decreasing to 2 percent of GDP in 2022. - Structural deficit is estimated to enter an adjustment trajectory towards the MTO as of 2021, reaching 2.4 % of GDP in 2022. - Authorities reaffirm commitments to the EU fiscal framework and consistency between policy objectives and sound public finances, while acknowledging challenges to meet 2019-2020 targets. - Implementation of the recently adopted Pension Law will be matched by strong fiscal-structural reforms and the benefit increase will be subject to existing available fiscal space. - Risks to debt sustainability are low: public debt-to-GDP ratio was 35.0 percent at end-2018, and the DSA projects the ratio to remain below the 60 percent threshold under all stress test scenarios. ### Financial sector soundness and regulation - The banking system is sound; NPL ratios continued to decrease and advanced toward the EU average. - NPL reached less than 5 percent at end-2018 (from 21.5 percent in 2013). - Non-performing loans provisioning was 58.5 percent at end-2018, well above the EU-wide average. - Capitalization of the banking sector remained around 18 percent. - Profitability indicators at end-2018: ROA 1.6 percent and ROE 14.6 percent, both above the EU average. - Ten-year average rankings placed the Romanian banking sector 12th (ROA) and 8th (ROE) among the EU’s 28 Member States. - A 40 percent ceiling on households’ total level of indebtedness was introduced on January 1, 2019 to prevent excessive indebtedness and loan portfolio deterioration. - Systemic risk buffers came into effect starting in June 2018. - Authorities share concerns over the sovereign-bank nexus and are considering introducing a systemic risk buffer while conducting impact analyses. - New legislation adopted in July 2019 strengthened the AML/CFT framework; ongoing efforts aim for full FATF standards compliance. - The unpredictability following GEO 114/2018 heightened legislative risks for the financial sector; deficiencies were significantly reduced by the adoption of GEO 19 in March 2019. ### Structural reforms, SOEs, and EU funds absorption - Authorities recognize the need to improve corporate governance of SOEs, restructure loss-making SOEs, and reduce budget drains to raise EU funds absorption. - Steps taken include restructuring major energy producers and preparing IPOs for some SOEs; selection of private management for SOEs in energy and transportation sectors is underway. - The establishment of the Sovereign Fund for Development and Investments is no longer on the Government’s agenda. - Measures under GEO 114/2018 aimed to stimulate the construction sector; a new PPP framework was adopted to provide additional infrastructure funding. - EU funds remain a critical source for investment; significantly improved absorption is a top priority. - Progress has been made to expedite assessment processes, improve implementation of large infrastructure projects, and reduce administrative burden. - Authorities will focus on accelerating program implementation, maximizing EU funds impact, and increasing transparency and accountability. ### Policy recommendations and commitments - Authorities broadly agreed with staff findings and recommendations from the Article IV mission and will carefully consider staff recommendations. - Agreed priorities include: - Reforming tax administration, upgrading IT infrastructure, and adopting modern compliance risk management with FAD technical assistance to improve revenue collection. - Increasing expenditure efficiency and transparency via strengthened expenditure reviews and procurement processes. - Matching Pension Law implementation with fiscal-structural reforms and limiting benefit increases to available fiscal space. - Continuing to monitor and ensure banking sector capital and liquidity adequacy. - Considering a systemic risk buffer while assessing potential financial stability implications. - Continuing anti-corruption efforts; authorities indicated no further judicial system initiatives will follow. - Authorities reiterated commitment to promoting sustainable and inclusive growth, improving competitiveness, reducing vulnerabilities, and improving EU funds absorption. *Statement by Mr. Anthony de Lannoy, Mr. Liviu Voinea, and Mr. Mugur Dragos Tolici, August 28, 2019.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2019/1romea2019001.pdf_