## _cr06168 ## Source details **Canonical URL:** [_cr06168](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06168.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06168.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06168.pdf.json) --- ### Executive summary — key findings and indicators - Real GDP growth: 4.1 percent in 2005 (2004: 8.4 percent). - Staff baseline projection for GDP growth: 5.2 percent in 2006. - CPI inflation: 8.6 percent y-o-y in December 2005; 8.5 percent y-o-y in February 2006. NBR target: 7.5 percent (±1 percent band). Staff projection: 6.5 percent at end-2006. - Current account deficit: 8.7 percent of GDP in 2005 (8.5 percent in 2004). Staff scenario projects 8.5 percent of GDP in 2006. - Reserve cover (months of imports): 4.1 in 2004; 5.6 in 2005. Staff projection: 6.6 in 2006 (staff scenario). - Gross external debt: 35.1 percent in 2004; 32.4 percent in 2005. Debt-stabilizing benchmark: current account deficit of -8.0 percent of GDP would stabilize gross external debt-to-GDP at 35 percent over the medium term. - Real domestic credit growth: real domestic credit grew by 45 percent in 2005 (table reports 44.7 percent). - Non-debt-creating inflows assumed average in debt sustainability scenario: 5 percent of GDP over 2006–11. - Staff baseline projection for public debt (percent of GDP): 18.9 in 2005; 16.7 in 2006 (staff proj.). ### Outlook and vulnerabilities - Growth outlook: - Recovery in agriculture and industry expected to drive growth to 5.2 percent in 2006. - Staff baseline/forecast comparison (selected): real GDP growth 2005: 4.1; 2006 baseline: 5.4; 2006 staff proj. with policy change: 5.2; 2007 baseline: 5.1; 2007 staff proj.: 5.6. - Inflation and disinflation: - Disinflation slowed despite leu appreciation; credibility of new inflation-targeting regime needs to be firmly established. - Staff proj. CPI (end-period): 2005: 8.6; 2006 baseline: 7.5; 2006 staff proj.: 6.5; 2007 staff proj.: 4.0. - External vulnerabilities: - Current account deficits widened historically: -8.7 percent of GDP in 2005. - Rising FDI and EU transfers covered about 90 percent of the current account in 2005; private capital inflows financed the remainder and supported reserve accumulation (official reserves: 22,866 US$ million end-2005; projected 28,643 US$ million end-2006). - Debt sustainability sensitivities: - Under a pessimistic scenario with lower inflows and GDP growth the debt-to-GDP ratio could rise to 45 percent over the medium term. - A 10 percent real depreciation combined with a sudden stop of non-debt-creating flows in 2006 would raise external debt by 17 percentage points of GDP on impact. - Stress tests: an average 1 percent of GDP widening of the current account deficit would result in gross external debt of 40 percent over the medium term; a sharp real depreciation could raise the debt-to-GDP ratio above 46 percent on impact. ### Macroeconomic policy recommendations (staff position) - Fiscal policy: - Fiscal consolidation should be the centerpiece of the macro strategy to stem excess demand and keep public finances sustainable. - Staff advocated a balanced budget in 2006 and small surpluses over the medium term; staff recommended measures equivalent to 1 percent of GDP in the scenario. - Options to strengthen revenue permanently: increase in the VAT; revisiting the rate of the flat tax; broadening the tax base; increasing property taxes; increasing administrative fees; improving revenue administration. - Timing: significant revenue-raising measures should be approved in the first half of the year to take effect no later than January 2007. - Wage and incomes policy: - Prudent public-sector wage policy is critical for disinflation: wage increases only once a year; announced 2006 wage increases of 12-15 percent incompatible with NBR’s 5-percent objective. - Freeze on vacant general government positions (except EU accession-related hiring) recommended; staff urged cancellation of bonuses and close monitoring of wage developments. - Monetary and exchange-rate policy: - Strengthen NBR’s inflation-targeting credibility by tightening monetary policy; staff urged an immediate increase of both the policy and effective rates of at least 100 basis points and possibly further increases. - FX interventions should be fully sterilized at the policy rate and focused on reducing excess volatility rather than controlling long-term trend. - Developments after mission: NBR increased policy rate by 100 basis points to 8.5 percent in early February 2006 and stepped up sterilization operations, bringing the effective interest rate in line with the policy rate. - Financial sector: - Financial soundness indicators point to a relatively healthy and resilient banking system; continue implementing FSAP recommendations and strengthen NBR risk-assessment capacity (Basel II preparation). - Prudential restrictions on credit flows should not substitute for traditional stabilization instruments; monitor foreign-currency lending and nonbank financial institutions. - Structural reforms: - Maintain momentum on privatization (including CEC), continue energy price adjustments to reach import parity, make the labor market more flexible, strengthen governance, and improve the business climate to sustain convergence to EU living standards. ### Fiscal, monetary and balance-sheet developments — selected exact figures and indicators - Key macro indicators (selected, exact figures from source table): - Real GDP growth (percent): 2000: 2.1; 2001: 5.7; 2002: 5.1; 2003: 5.2; 2004: 8.4; 2005: 4.1. - CPI (end of period): 2000: 40.7; 2001: 30.3; 2002: 17.8; 2003: 14.1; 2004: 9.3; 2005: 8.6. - Current account deficit (percent of GDP): 2000: -3.7; 2001: -5.5; 2002: -3.3; 2003: -5.8; 2004: -8.5; 2005: -8.7. - General government deficit (percent of GDP): 2000: -4.0; 2001: -3.2; 2002: -2.6; 2003: -2.2; 2004: -1.0; 2005: -0.8. - Reserve cover (months of imports): 2000: 2.3; 2001: 3.5; 2002: 3.6; 2003: 2.8; 2004: 4.1; 2005: 5.6. - Gross external debt (percent of GDP): 2000: 29.8; 2001: 32.8; 2002: 32.8; 2003: 32.9; 2004: 35.1; 2005: 32.4. - Demand contributions to real GDP growth in 2005 (components, exact figures): - Domestic demand contribution: 9.1 (of which consumption 7.4; households 6.5; government 0.9). - Fixed capital formation contribution: 2.8 (non-government 2.8; government 0.0). - External demand contribution: -5.0. - Selected monetary and financial indicators (exact): - Real domestic credit (end of year, percent change): 2004: 40.4; 2005: 44.7; 2006 (Proj.): 33.8. - Broad money (end of year, percent change): 2004: 40.1; 2005: 33.8; 2006 (Proj.): 24.3. - NBR interest rate (end of period): 2004: 18.8; 2005: 7.2; 2006 (last observation for February 2006): 8.5. ### Current account, external financing, and debt sustainability - 2005 financing structure: - Rising FDI and EU transfers covered about 90 percent of the current account; private capital inflows financed the remainder and supported substantial reserve accumulation (official reserves rose by almost $8 billion in 2005 to 22,866 US$ million). - Debt sustainability scenario key assumptions and projections (exact figures from Box 2/Table 12): - Assumed average non-debt-creating flows: 5 percent of GDP (2006–2011). - Nominal GDP growth (US$ terms) average: 30.6 in 2005; 14.2 over 2006–2011. - Real GDP growth assumed: 4.1 (2005); 5.6 (2006–2011). - Implied real exchange rate appreciation (GDP deflator): 12.0 (2005); 5.4 (2006–2011). - Nominal exchange rate appreciation (period average): 12.0 (2005); 2.6 (2006–2011). - Current account balance consistent with stable external debt ratio at 35 percent: -8.0 (percent of GDP). - External debt baseline trajectory (selected exact series from Table 12): - External debt (percent of GDP): 2006: 32.4; 2007: 31.3; 2008: 32.2; 2009: 33.4; 2010: 34.0; 2011: 35.2. - Gross external financing needs (US$ billion): 2006: 16.7; 2007: 19.7; 2008: 22.1; 2009: 25.3; 2010: 28.3; 2011: 31.6. - Gross external financing need (percent of GDP): around 14–15 percent over projection period. - Sensitivity / stress tests (selected outcomes): - B3: average 1 percent of GDP widening of current account deficit → debt-to-GDP ratio of 40 percent over the medium term. - A 10 percent real depreciation + sudden stop of non-debt flows in 2006-07 produces large one-off increases (scenario entries: e.g., -6.72/ and -5.91/ noted in source charts). ### Competitiveness, exports, and sectoral developments - Exchange rate and wages: - Effective exchange rate indicators appreciated significantly during September 2004–December 2005: ULC-based REER appreciated by 17 percent; CPI-based REER appreciated by 21 percent. - Enterprise profitability in manufacturing appears to have deteriorated due to wage growth and slowdown in productivity, partially offset by export price growth. - Export performance: - Romania’s total and non-oil exports grew by 20 percent in 2005. - Manufacturing exports represent 2/3 of total exports and grew in 2005. - Sectoral export growth in 2005: machinery and equipment exports 26 percent; food and plastic products 20 percent; textiles (20 percent of exports) decelerated; wood products flat. - Imports of machinery (percent of total imports, selected entries; Romania noted): - Romania: 22.1; 25.0; 23.4 (source footnote: Romania's share was about 25 percent in 2005). - Equilibrium indicators: - Cross-country panel on manufacturing wages indicates Romania’s real exchange rate was significantly undervalued in the 1990s; implied undervaluation narrowed sharply since 2000 but a gap of some 20-30 percent between actual and equilibrium wages remains. ### Fiscal developments, tax policy, and public spending - General government deficit developments: - General government deficit: -1.0 percent of GDP in 2004 (outturn); -0.8 percent in 2005. - Authorities approved a revised 2006 budget increasing the deficit from 0.5 to 0.9 percent of GDP (later staff view pegs underlying deficit about 1 percent of GDP). - Revenue and tax changes (exact measures and effects): - Tax changes effective January 1, 2005: profit tax cut from 25 percent to 16 percent; single personal income tax rate of 16 percent replacing progressive scale; tax on micro-enterprises increased; planned cut in social contributions rate cancelled. - Additional changes May/June 2005: increase in excises; tax on interest and short-term capital gains increased from 1 to 10 percent; tax on gambling increased to 16 percent; profit tax, VAT, and excise bases broadened. - Revenue loss from personal income and profit tax cuts (compared with 2004) ≈ 1 percent of GDP; compared with baseline of no tax cuts, loss ≈ 1½ percent of GDP. This loss was offset by better-than-budgeted VAT collections due to strong consumption. - 2006 budget measures reported: reduction in social contributions rate to 47½ percent; increase in agricultural land tax; increase in tax on interest, dividends, and short-term capital gains to 16 percent; increases in excises effective July 2006. - Expenditure developments: - Large overruns in the wage bill and significant cuts in capital expenditure relative to budget in 2005. - Public-sector wage increases between October 2004 and October 2005: up to 50 percent; average public-sector wage increases in 2005: 16-34 percent; effect: increased the wage bill by 0.6 percentage points of GDP. - December 2005 fiscal relaxation: surplus of 1 percent of annual GDP during January–November, but December clearing of arrears, flood repairs, and capital injection into Exim Bank constituted substantial fiscal expansion. ### Structural reforms, privatization, and governance - Privatization: - Large-scale privatization continued, including sale of BCR; sale of CEC expected; projected privatization proceeds about 3 percent of GDP in 2006. - Staff urged continuation of privatization of CEC, Romgaz, and other companies. - Energy and mining: - Gas prices (domestic producer) reported at 38 percent of international import price; staff urged schedule to reach import parity over medium term (commitment to eliminate gap by end-2008 noted). - Tariff and heating reforms ongoing (national reference price for heating increased; new two-part heating tariff introduced). - Progress on mining sector strategy implementation commended. - Labor market and judicial reforms: - Amendments to the Labor Code introduced short-term contracts, extended probation, more flexible hours, employer’s right to retrench for economic reasons; staff judged these measures fall short of eliminating main rigidities. - Judicial reform progressed; National Anticorruption Prosecutor’s Office established to investigate and prosecute members of parliament. - Governance and public spending management: - Need to absorb EU grants effectively and improve public spending management and transparency; World Bank assistance supporting civil service, health, and pension reforms. ### Fund relations, mission, and technical notes - Mission composition: Messrs. van der Mensbrugghe (head), Christou, Tiffin, and Adler (EUR), Roger (MFD), Ms. Vera Martin (PDR); Ms. Schadler (EUR) joined for a few days; resident representative Mr. Justice assisted; Mr. Croitoru (OED) participated in policy discussions. - Meetings: President, Prime Minister, Deputy Prime Minister, Ministers (Public Finance, Economy, Labor, Transportation); Governor of NBR; parliamentarians; EC, EBRD, IBRD; academics; bankers; unions; employers; foreign investors council. - Fund program history: - On July 7, 2004 the Executive Board concluded the 2004 Article IV consultation and approved a 24-month precautionary Stand-By Arrangement (SDR 250 million (24.27 percent of quota)). First review completed September 22, 2004. - Authorities confirmed intention not to resume completion of SBA reviews prior to expiration in July 2006. - Data and statistics: - Romania subscribed to the SDDS in May 2005. Statistical base adequate for surveillance, but national accounts, price, fiscal, and balance-of-payments data quality needs improvement; monetary statistics reporting uses SRFs since December 2004. - Consolidated central government operations reported annually for GFS Yearbook and quarterly for IFS; fiscal accounts produced on new 2006 budget classification for 2004–05 outturns. *Source: IMF staff report excerpt (2006) contained in _cr06168.* ### 2006. The mission comprised Messrs. van der Mensbrugghe (head), Christou, ### _cr06168 - 2006. The mission comprised Messrs. van der Mensbrugghe (head), Christou, ### Executive Summary — Key findings and indicators - Real GDP growth slowed to 4.1 percent in 2005; growth aided by an exceptional harvest in 2004 (8.4 percent) and slowed in 2005 due to floods and weaker industry. - CPI inflation: 8.6 percent y-o-y in December 2005; 8.5 percent y-o-y in February 2006. NBR target was 7.5 percent (with a ±1 percent band). - Current account deficit: 8.7 percent of GDP in 2005 (8.5 percent in 2004). Staff scenario projects a current account deficit of 8.5 percent of GDP in 2006. - Staff baseline projection for GDP growth: 5.2 percent in 2006. - Staff projection for inflation: 6.5 percent at end-2006. - Reserve cover (months of imports): 4.1 in 2004; 5.6 in 2005. - Gross external debt: 35.1 percent in 2004; 32.4 percent in 2005. - Real domestic credit growth: real domestic credit grew by 45 percent in 2005. - Non-debt-creating inflows assumed average: 5 percent of GDP over 2006–11 in the debt sustainability scenario. - Debt sustainability benchmark: a current account deficit of 8 percent of GDP on average would stabilize gross external debt-to-GDP at 35 percent over the medium term (Box 2). ### Outlook and vulnerabilities - Growth outlook: Recovery in agriculture and industry expected to drive growth to 5.2 percent in 2006. - Inflation and disinflation: Disinflation has slowed despite leu appreciation; disinflation credibility of the new inflation-targeting regime needs to be established firmly. - External vulnerabilities: Current account deficits widened to historically large levels (8.7 percent of GDP in 2005), but rising FDI and EU transfers covered about 90 percent of the current account in 2005; private capital inflows financed the remainder and supported reserve accumulation. - Debt sustainability sensitivities: Under a pessimistic scenario with lower inflows and GDP growth the debt-to-GDP ratio could rise to 45 percent over the medium term. A 10 percent real depreciation combined with a sudden stop of non-debt-creating flows in 2006 would raise external debt by 17 percentage points of GDP on impact. ### Macroeconomic policy recommendations (staff position) - Fiscal policy: - Fiscal consolidation should be the centerpiece of the macro strategy to stem excess demand and keep public finances sustainable over the medium term. - Staff advocated a balanced budget in 2006 and small surpluses over the medium term. - Given tight expenditure constraints and infrastructure/EU co-financing needs, strengthen the revenue base. - Wage policy: - A prudent wage policy is critical for successful disinflation; government wage policy should be recalibrated to low-inflation needs, featuring wage increases only once a year. - Authorities should exercise prudence in SOE- and minimum-wage policies and freeze non-EU-related vacant positions (authorities reported such a freeze). - Monetary and exchange rate policy: - Tighten monetary policy to re-establish credibility of inflation targeting; staff urged an increase in interest rates. - Intervention in the foreign exchange market should be fully sterilized and focused on reducing excess volatility rather than controlling the longer-term trend. - In early-February (2006), the NBR increased its policy rate by 100 basis points and stepped up sterilization operations, bringing the effective interest rate in line with the policy rate. - Financial sector: - Financial soundness indicators point to a relatively healthy and resilient banking system; continue implementing FSAP recommendations. - Structural reforms: - Maintain momentum on privatization; continue energy price adjustments; make the labor market more flexible; strengthen governance; and improve the business climate to sustain rapid convergence to EU living standards. ### Fiscal, monetary and balance-sheet developments — Selected exact figures and indicators - Key Macroeconomic Indicators (2000–05 table excerpts, in percent unless otherwise indicated): - Real GDP growth: 2000: 2.1; 2001: 5.7; 2002: 5.1; 2003: 5.2; 2004: 8.4; 2005: 4.1. - CPI (end of period): 2000: 40.7; 2001: 30.3; 2002: 17.8; 2003: 14.1; 2004: 9.3; 2005: 8.6. - Current account deficit: 2000: -3.7; 2001: -5.5; 2002: -3.3; 2003: -5.8; 2004: -8.5; 2005: -8.7. - General government deficit: 2000: -4.0; 2001: -3.2; 2002: -2.6; 2003: -2.2; 2004: -1.0; 2005: -0.8. - Reserve cover (months of imports): 2000: 2.3; 2001: 3.5; 2002: 3.6; 2003: 2.8; 2004: 4.1; 2005: 5.6. - Gross External Debt: 2000: 29.8; 2001: 32.8; 2002: 32.8; 2003: 32.9; 2004: 35.1; 2005: 32.4. - Demand contributions to real GDP growth (2005 components): - Domestic demand contribution: 9.1 (of which consumption contributed 7.4; households 6.5; government 0.9). - Fixed capital formation contribution: 2.8 (non-government 2.8; government 0.0). - External demand contribution: -5.0. - Credit and exchange rate measures (Box 1 summary of measures taken in 2005–2006): - July 2005: Reserve requirement of 30 percent extended to all foreign currency-denominated liabilities. - August 2005: Reserve requirement on RON-denominated liabilities with maturities less than 2 years lowered from 18 to 16 percent. - August 2005: Household-lending risk limits tightened: monthly debt-service ceiling of 40 percent of net monthly income; consumer and real-estate credit ceilings of 30 and 35 percent respectively. - September 2005: For FX loans, exposure to unhedged borrowers limited to 300 percent of creditor’s own funds (only borrowers with foreign currency income considered hedged). - December 2005 and February 2006: Reserve requirement on foreign currency-denominated liabilities increased from 30 percent to 35 percent, and then to 40 percent. ### Current account and external financing - 2005 financing: Rising FDI and EU transfers covered about 90 percent of the current account; private capital inflows financed the remainder and supported substantial reserve accumulation. - Debt sustainability scenario assumptions and sensitivities (Box 2): - Assumed average non-debt-creating flows: 5 percent of GDP (2006–2011). - Nominal GDP growth (in US Dollar terms) average: 30.6 in 2005 and 14.2 over 2006–2011 (table shows 30.6 for 2005; 14.2 for 2006-2011). - Real GDP growth assumed: 4.1 (2005) and 5.6 (2006-2011). - Implied real exchange rate appreciation (based on GDP deflator): 12.0 (2005) and 5.4 (2006-2011). - Nominal exchange rate appreciation (period average): 12.0 (2005) and 2.6 (2006-2011). - Current account balance consistent with stable external debt ratio at 35 percent: -8.0 (percent of GDP). ### Mission, consultations, and data/technical notes - Mission composition: Messrs. van der Mensbrugghe (head), Christou, Tiffin, and Adler (all EUR), Roger (MFD), and Ms. Vera Martin (PDR); Ms. Schadler (EUR) joined for a few days; resident representative Mr. Justice assisted. Mr. Croitoru (OED) participated in policy discussions. - Meetings: President, Prime Minister, Deputy Prime Minister, Ministers of Public Finance, Economy, Labor, and Transportation; Governor of the National Bank of Romania (NBR); other senior officials; members of parliament (including opposition); EC, EBRD, IBRD; academics; bankers; labor unions; employers’ associations; foreign investors council. - Fund relations and program: On July 7, 2004 the Executive Board concluded the 2004 Article IV consultation and approved a 24-month precautionary Stand-By Arrangement (SDR 250 million (24.27 percent of quota)). The first review was completed September 22, 2004. No other reviews have been concluded. - Data and statistics: Romania subscribed to the Special Data Dissemination Standard in May 2005. Statistical base adequate for surveillance, but national accounts, price, fiscal, and balance-of-payments data quality needs improvement (Appendix III). - Communication: The mission held a press conference and the authorities published the mission’s concluding statement. *Source: IMF staff report excerpt (2006) contained in _cr06168.* ### 3.5 percent. ### _cr06168 - 3.5 percent. ### Current account, external debt, and shocks - Scenario outcomes (annual percentage changes / in percent of GDP) shown for shocks: - (b) A 10 percent real depreciation and a sudden-stop of non-debt flows in 2006-07: -6.72/ - Another scenario entry: -5.91/ - Memorandum items: - Actual/projected current account balance -8.7-8.1 - Actual/projected gross debt ratio 32.4 33.1 - Footnotes: - 1/ Current account that the stabilizes debt-to-GDP ratio at 35 percent by 2011. - 2/ Required current account deficit during 2007-11 to bring the debt-to-GDP ratio back to 35 percent. - Charts and narratives indicate external debt path scenarios (Baseline, Adj. Scenario, No Adjustment) projecting external debt to 2011 with reference points at 30, 35, 40, 45, 50, 55, (and 60 in one chart) percent of GDP. ### Drivers of the widening current account deficit - Findings: - Romania’s high rate of return on capital is attracting foreign savings needed for EU integration. - Per capita FDI remains relatively low but "has picked up recently, reflecting increased confidence in Romania’s prospects." - Consumption is booming; composition of imports has not changed substantially. - Share of machinery in total imports—an indicator of investment activity—has remained constant and is well below shares in recent EU entrants. - Imports of Machinery (Percent of total imports), selected entries: - Hungary 23.6 43.4 44.5 - Czech Republic 30.4 31.7 32.9 - Poland 25.6 26.8 25.2 - Romania 2/ 22.1 25.0 23.4 - Bulgaria 12.6 16.9 18.5 - Lithuania 16.1 15.8 19.3 - 2/ Romania's share was about 25 percent in 2005. - FDI (net) in Transition Economies, 1995-2005 (US$ per capita, annual average): - Graphical evidence: FDI inflows to Romania have picked up recently, although they remain low compared to EU new member states. ### Competitiveness (Box 3) - Exchange rate and wage dynamics: - All effective exchange rate indicators appreciated significantly during September 2004-December 2005: - ULC-based REER appreciated by 17 percent. - CPI-based REER appreciated by 21 percent. - Enterprise profitability in manufacturing appears to have deteriorated due to wage growth and a slowdown in productivity, partially offset by strong growth in export prices. - Export performance: - Romania’s total and non-oil export performance remained strong with 20 percent growth during 2005. - Manufacturing exports represent ⅔ of total exports and grew in 2005. - Significant sectoral growth in 2005: - Machinery and equipment exports: 26 percent. - Food and plastic products: 20 percent. - Textiles (20 percent of exports) decelerated; wood products were flat. - Equilibrium indicators and wage gaps: - Cross-country panel analysis (85 countries) using manufacturing wages in U.S. dollars indicates Romania’s real exchange rate had been significantly undervalued throughout the 1990s. - Implied extent of undervaluation has narrowed sharply since 2000, especially in 2005, but a gap of some 20-30 percent between the actual and the equilibrium wage remains. - PPP-based measures show Romania undervalued against a world benchmark for much of the transition period, though arguably overvalued compared to the EU-transition group. - Policy implication from staff analysis: - There exists a margin for further appreciation, at a measured pace, without causing a significant deterioration in the external balance; the 2005 exchange-rate developments form part of a larger structural convergence process. ### Export performance and sectoral detail - Export growth metrics (annual average growth rates, 1995-2005) for selected countries and periods are reported (table entries preserved in source). - Main export products, 2002-05 (value, 12 month-over-12 month growth rate) show divergent sectoral dynamics (textiles, machinery, chemical products and metals, other manufactures). ### Fiscal developments and consolidation - General government deficit developments: - Further fiscal consolidation occurred last year; the general government deficit was kept to 0.8 percent of GDP—against a revised target of 1 percent of GDP and a deficit of 1 percent of GDP in 2004. - General Government Balances, 2004-06 (In percent of GDP): - Total revenue: 30.1 32.1 31.5 30.3 31.5 30.6 (columns reflect Outturn, Original, 4th Suppl., Prel. Estimates, Approved Budget, Staff Proj. as in source) - Tax revenue: 27.1 28.0 27.6 27.3 27.9 27.2 - personal income tax: 2.9 3.0 2.3 2.4 2.6 2.6 - profit tax: 2.6 2.6 2.4 2.3 2.3 2.3 - VAT: 6.7 7.1 7.9 7.8 8.1 7.9 - Total expenditure: 31.1 33.6 32.6 31.1 32.0 31.5 - current expenditure: 28.3 29.2 29.6 28.4 28.8 28.4 - wages: 4.8 5.0 5.7 5.4 5.5 5.2 - goods and services: 7.3 7.2 7.3 7.5 6.4 6.8 - capital expenditure: 2.8 4.3 2.9 2.6 3.2 3.1 - Measures to reach target: ...............1.0 - Overall balance: -1.0 -1.5 -1.0 -0.8 -0.5 0.0 - Sources: Romanian authorities; and Fund staff estimates and projections. - 1/ Revised budget in December 2005. - 2/ On the basis of a balanced budget; and measures equivalent to 1 percent of GDP. - Revenue and expenditure developments: - Introduction of the flat tax resulted in a loss in personal income and profit tax collections of about 1 percent of GDP (Box 4). - This loss was offset by higher-than-budgeted indirect tax collections due to strong demand. - On the expenditure side, large overruns in the wage bill and significant cuts in capital expenditure occurred relative to budget. - Low absorption of external grants led to co-financing shortfalls. - Significant fiscal relaxation in December 2005: the budget recorded a surplus of 1 percent of annual GDP during January-November, but December saw clearing of arrears, flood-related repairs, and capital injection into Exim Bank—constituting a substantial fiscal expansion. ### Tax policy (Box 4) - Tax changes effective January 1, 2005: - Profit tax cut from 25 percent to 16 percent. - Single personal income tax rate of 16 percent replaced progressive five-bracket scale with rates of 18-40 percent. - Tax on micro-enterprises was increased. - An already-approved cut in the social contributions rate was cancelled. - Additional changes effective May/June 2005: - Increase in excises (brought forward and increased further). - Tax on interest and short-term capital gains increased from 1 to 10 percent. - Tax on gambling increased to 16 percent. - Profit tax, VAT, and excise-tax bases were broadened. - Revenue impacts: - The revenue loss from the cut in the personal income and profit tax (compared with 2004) amounts to about 1 percent of GDP. - Compared with the baseline of no tax cuts, the loss is about 1½ percent of GDP. - This loss was compensated by better-than-budgeted VAT collections mainly on account of strong consumption. - 2005/2004 comparative tax revenue table (in percent of GDP) preserved in source: - Tax Revenue 27.1 (2005 Actual) 28.0 (2005 Budget) 28.4 (No Tax Changes) 27.3 (2004 Outturn) - Corporate income tax 3.0 2.8 3.3 2.7 - Personal income tax 2.9 3.0 3.2 2.4 - VAT entries as reported in source across columns. - 2006 budget measures (as reported): - Reduction in the social contributions rate to 47½ percent. - Increase in the agricultural land tax. - Increase in the tax on interest, dividends, and short-term capital gains to 16 percent. - Increases in excises (effective July 2006). ### Wages, pensions, and domestic demand pressures - Public-sector wage dynamics: - Following substantial increases in late-2004, public-sector wages increased in two rounds during 2005, rising by up to 50 percent between October 2004 and October 2005. - Average public-sector wage increases in 2005: 16-34 percent. - Effect: increased the wage bill by 0.6 percentage points of GDP. - Recalculation of pensions for those retired before 2001 also increased government spending. - Real wages by sector chart indicates public-sector real wage growth has outpaced private sector growth. ### Monetary policy, inflation, and exchange-rate regime - Pre-2005 framework: - Until end-2004, the NBR used the exchange rate as an implicit nominal anchor, guiding the rate to match disinflation goals while allowing some real appreciation. - Restrictions on short-term capital inflows aided the NBR’s autonomy in setting its policy interest rate. - Liberalization and interest rate movements: - Capital account liberalization: as of April 2005 non-residents allowed to hold local-currency deposits; as of February 2006 they are also allowed to hold treasury bills. - NBR policy interest rate reduced from 21¼ percent in June 2004 to 7½ percent at end-2005. - Inflation-targeting adoption and practice: - NBR announced shift to inflation-targeting in August 2005. - Facing upward pressure on the exchange rate, NBR reduced sterilization efforts in September 2005—refusing to absorb full excess liquidity—driving its effective interest rate significantly below its headline policy rate. - Throughout the final quarter of 2005, the effective interest rate was deeply negative in real terms. - The drop in the effective interest rate helped arrest short-term pressure on the exchange rate. - With less exchange-rate pressure, the NBR refrained from intervention since November 2005 and has gradually increased sterilization and the effective interest rate. - Data highlights (from charts and narrative): - CPI-based and ULC-based Real Effective Exchange Rates, and NBR net purchases of foreign exchange (million euros) and effective interest rate (percent) show exchange-rate considerations guided monetary policy even after IT adoption. ### Structural reforms and legal/regulatory developments - Privatization and markets: - Large-scale privatization continued (including sale of Romania’s largest bank (BCR), expected to be completed shortly). - Government reconsidering strategy for privatizing remaining publicly-owned bank (CEC). - Privatization and deregulation of electricity and gas markets continued; national reference price for heating increased; new two-part heating tariff introduced. - Gas prices (producer and retail) have not adjusted to opportunity costs; domestic producer price is now 38 percent of the international import price. - Labor market and judicial reforms: - Parliament approved amendments to the Labor Code: use of short-term contracts, extension of probation period, more flexible working hours, introduction of employer’s right to retrench for economic reasons—though amendments fall short of eliminating main sources of labor-market rigidity. - Judicial reform progressed; establishment of a National Anticorruption Prosecutor’s Office able to investigate and prosecute members of parliament. - Other: - Significant progress in implementation of the mining sector strategy. - Little progress on liquidation of Rafo, a large oil refinery and one of the biggest debtors to the budget. *Source: _cr06168 - 3.5 percent.* ### 10. Discussions focused on policies for reducing imbalances and setting the stage for ### _cr06168 - 10. Discussions focused on policies for reducing imbalances and setting the stage for ### Summary of discussions and key questions - With slowing growth, disinflation, and a widening current account deficit, participants agreed decisive action was needed to avoid deterioration. - Key questions discussed: - What is the most appropriate policy mix to reduce imbalances and best support the authorities’ growth and inflation objectives in a new era of no capital controls? - Can Romania bring inflation down to low single digits without relying as much on exchange rate appreciation and thus losing competitiveness and threatening growth? - How can fiscal policy respond to substantial expenditure needs and raise resources to cover EU accession-related expenditures, while lowering the burden on monetary policy to lower inflation? - What are the main elements of the structural reform agenda that will help Romania’s convergence to EU living standards? ### Macroeconomic outlook, vulnerabilities, and risks - Staff assessment and agreed judgments: - Sustaining strong growth requires macroeconomic stabilization and renewed reform; a tightening of macroeconomic policies is needed to resume disinflation and contain external imbalances. - Tighter fiscal and incomes policies will allow monetary policy to fight inflation without excessive upward pressure on the exchange rate. - The leu appreciation had narrowed the margin, but the exchange rate remained competitive. - Staff projection under an appropriate policy mix: - Real GDP growth in 2006: 5.2 percent (projected). - Inflation (staff scenario): 6.5 percent (end-2006 outcome projected). - Current account deficit (staff scenario): 8.5 percent of GDP. - Drivers: recovery in agriculture and industry; domestic demand growth will slow due to fiscal consolidation, more moderate wage growth, and monetary tightening. - Risk assessment: - Short-term risk indicators low (external and public debt levels low; reserve coverage comfortable). - Medium-term risks substantial without policy shift: continued inflationary pressures, deterioration in external competitiveness, widening current account deficit, potential boom-bust cycle. - Vulnerability to boom-bust could strain household and enterprise debt-service capacity and the banking system. ### Fund policy recommendations and implementation (Box 5) - Fiscal policy: - Fiscal consolidation continued, but last year’s tax cuts led to a significant revenue loss and were not accompanied by sufficient broadening of the tax base. - Progress on tax administration and articulation of a medium-term fiscal framework has been slow. - Monetary policy: - Over the past two years, monetary policy broadly in line with Fund advice and successful in bringing inflation down to single digits, albeit slower than expected. - Wage policy: - Substantial wage increases in general government during 2004-06 not in line with Fund’s recommendation for prudent wage policy and have threatened macroeconomic stability. - Wage policy in SOEs and minimum wage increases during 2005-06 were more prudent. - Structural policies: - Significant progress on privatization; energy pricing broadly in line with Fund recommendations. - Domestic gas prices have fallen behind international prices. - Labor market flexibility improved only marginally. - Efforts to increase independence and effectiveness of the judiciary should help the business climate. ### Growth prospects and long-term scenarios (Box 6) - With suitable policies, staff sees sustainable economic growth at 5-6 percent. - Convergence to EU living standards will require increased investment and employment creation, aided by EU transfers and foreign savings, plus privatization and enterprise restructuring to sustain productivity gains. - Three quantitative scenarios for 2006-2015 (efficiency defined relative to international best practice): - High-case: - Efficiency improvement from 50 to 70 percent. - Total Factor Productivity (TFP) growth: 4.6. - Avg. real investment growth: 8.0. - Avg. real output growth: 7.5. - Output per worker: 7.3. - Capital per worker: 2.1. - Medium-case (staff baseline): - Efficiency improvement from 50 to 60 percent. - TFP growth: 2.6. - Avg. real investment growth: 6.0. - Avg. real output growth: 5.0. - Output per worker: 4.9. - Capital per worker: 1.7. - Low-case: - No improvement in efficiency (remains at 50 percent). - TFP growth: 1.0. - Avg. real investment growth: 4.0. - Avg. real output growth: 3.0. - Output per worker: 2.9. - Capital per worker: 1.3. - Historical growth accounting (selected periods): - 1992-99 contributions: Capital 0.5, Labor 0.4, TFP -1.7, GDP growth 1.9. - 1999-2005 contributions: Capital 5.1, Labor 2.2, TFP -0.4, GDP growth 3.2. - 2005-11 contributions (projection): Capital 5.6, Labor 3.0, TFP -0.2, GDP growth 2.7. (Source: Fund staff estimates and projections.) ### Staff forecast and key macroeconomic indicators (2005-07) - Staff baseline vs. staff scenario (incorporating recommended policy mix including measures equivalent to 1 percent of GDP): - Real GDP growth (percent): - 2005: 4.1 (prel. estimates) - 2006 baseline: 5.4; staff proj. with policy change: 5.2 - 2007 baseline: 5.1; staff proj. with policy change: 5.6 - CPI (change in percent; end of period): - 2005: 8.6 - 2006 baseline: 7.5; staff proj.: 6.5 - 2007 baseline: 6.1; staff proj.: 4.0 - Current account deficit (percent of GDP): - 2005: -8.7 - 2006 baseline: -8.8; staff proj.: -8.5 - 2007 baseline: -8.6; staff proj.: -8.3 - General government deficit (percent of GDP): - 2005: -0.8 - 2006 baseline: -0.5; staff proj.: 0.0 - 2007 baseline: -1.0; staff proj.: 0.2 - Reserve cover (months of imports): - 2005: 5.6; 2006 baseline: 5.6; staff proj.: 6.6; 2007 proj.: 5.6 / 5.5 / 6.5 (table entries reflect authority and staff estimates) - Gross external debt (percent of GDP): - 2005: 32.4; 2006 baseline: 33.7; staff proj.: 32.4; 2007 proj.: 33.4 / 31.3 - Public debt (percent of GDP): - 2005: 18.9; 2006 baseline: 17.8; staff proj.: 16.7; 2007 proj.: 16.6 / 15.3 ### Savings–Investment balances (2004–06, percent of GDP) - Savings Rate: - 2004: 13.9 - 2005: 14.0 - 2006 staff proj.: 15.7 - Investment rate: - 2004: 22.3 - 2005: 22.7 - 2006 staff proj.: 24.2 - Savings–Investment Balance: - 2004: -8.5 - 2005: -8.7 - 2006 staff proj.: -8.5 - Notes: - Staff projections for 2006 assume a balanced budget and measures equivalent to 1 percent of GDP. - Staff's scenario assumes lower-than-budgeted capital spending (0.3 percent of GDP) in line with recent budget implementation trends. ### Fiscal policy: diagnosis and recommended actions - Strategic role: - Fiscal policy should be the centerpiece of the strategy to stem excess demand and keep public finances on a sustainable medium-term path. - Staff urged targeting a balanced budget in 2006 and small surpluses over the medium term. - Size of adjustment: - Authorities considered a 0.3 percent of GDP adjustment for 2006 (from last year’s outturn of 0.8 percent of GDP) as sufficient and felt small deficits could be accommodated in the medium term. - Staff indicated that with recent tax cuts and wage hikes, an underlying deficit of over 1 percent of GDP exists versus the approved deficit of 0.5 percent of GDP. - Revenue strengthening: recommended options to permanently strengthen revenue (listed by staff): - Increase in the VAT. - Revisiting the rate of the flat tax. - Broadening the tax base. - Increasing property taxes. - Increasing administrative fees. - Improving revenue administration. - Timing and legislative action: - Staff recommended significant revenue-raising measures be approved in the first half of the year to take effect no later than January 2007. - Authorities planned a comprehensive revision of the fiscal code later in 2006 but did not elaborate specifics; planned improvements in revenue administration expected to strengthen collections. - Revenue administration reform (with FAD and World Bank assistance): - Recommendations based on June 2004 FAD mission plan: - Establish full control of field offices. - Limit unified revenue agency role to revenue administration. - Eliminate restrictions on audits and arrears enforcement. - Harmonize tax and social requirements for income definitions and bases, eligibility determination, and payment. - Adopt a comprehensive plan to eliminate illegal trade in petroleum products and cigarettes and fight corruption in customs administration. - Caution: administration improvements take time to materialize. - Public-sector wage policy: - To anchor inflation expectations in low single digits, public sector wages should increase only once a year. - Announced average public sector wage increases for 2006 of 12-15 percent are incompatible with the NBR’s 5-percent inflation objective. - Authorities committed to one wage increase per year starting in 2007. - Minimum wage increase contained to 6.5 percent in 2006; SOE wage bill increase of 3.5 percent in 2006 considered prudent for monitored SOEs. - Additional fiscal measures: - Freeze on all vacant positions in general government (except EU accession-related hiring) to offset wage overruns. - Staff urged cancellation of bonuses and close monitoring of wage developments. - Risk flagged of using proceeds from sale of BCR for non-budgeted projects. - Without further revenue measures, meeting deficit targets may again squeeze capital expenditure. ### Energy pricing and competitiveness - Domestic wellhead gas price remains well below the international price. - Tariffs for the second quarter of 2006 are based on a Leu/$ exchange rate of 3.0, used by the authorities. - Staff noted energy pricing broadly in line with Fund recommendations, but domestic gas prices have fallen behind international prices. ### Structural reform priorities - To support convergence and higher sustainable growth, priorities include: - Absorbing EU grants effectively and accelerating public investment and infrastructure. - Implementing institutional and structural reforms to raise overall efficiency. - Continuing privatization and enterprise restructuring. - Improving labor market flexibility. - Enhancing independence and effectiveness of the judiciary to improve the business climate. *Source: _cr06168 - 10. Discussions focused on policies for reducing imbalances and setting the stage for* ### 21. The authorities acknowledged the fiscal-management challenges associated with ### _cr06168 - 21. The authorities acknowledged the fiscal-management challenges associated with ### Fiscal-management challenges and recommendations - Projected privatization proceeds of about 3 percent of GDP in 2006. - Projected EU transfers of over 2 percent of GDP in 2007. - Key staff assessments and recommendations: - Assess the macroeconomic impact of privatization proceeds and EU transfers. - Privatization inflows will help reduce public debt and support the pension reform, but may generate pressures for higher spending, resulting in higher deficits and weakening resolve for fiscal reform. - Develop a medium-term framework that fully incorporates: - revenue from privatization, - post-accession EU receipts and expenditures, - impact of ongoing reforms. - Put in place mechanisms to ensure efficient allocation of resources and absorption of EU inflows. - Improve transparency and candid communication to avoid surprises and improve budgetary controls. - Structural fiscal reforms are important to improve the quality of public expenditure as EU accession approaches. - World Bank assistance is supporting reforms of the civil service, health, and pension systems with objectives including overhauling pay and employment practices, improving quality of health services while containing costs, and introducing a second pension pillar. - Improve public spending management to ensure a uniform spending pattern over the year. ### Monetary policy: assessment, projections, and recommended actions - Staff view: need to strengthen confidence in the NBR’s commitment to inflation targeting. - Context and recent developments: - Introduction of inflation targeting coincided with strong capital inflows; the NBR intervened heavily in FX markets and cut interest rates rather than allow further appreciation. - The inflation target was missed four months after announcement, complicating anchoring of inflationary expectations. - Inflation projections and drivers: - Staff projections broadly in line with authorities imply the NBR was unlikely to meet its target for 2006. - Missing the 2006 target reflects: impact on expectations of the 2005 miss, delayed impact of monetary easing, and higher wages. - Planned increases in administered prices would likely add 2½-3 percentage points to the headline inflation rate. - Market forecasts for end-2006: generally within the 7-8 percent range. - Target-setting and credibility: - Little benefit in adjusting upward the inflation targets for 2006-07; a large revision of the 2006 target would be costly for NBR credibility. - Discussion should focus on the inflation forecast for end-2007 and include a credible action plan to achieve the 4-percent target by the end of this period. - Authorities agreed on need for supporting fiscal and incomes policy to achieve the inflation objective. - Recommended immediate policy action: - Staff urged an immediate tightening of monetary policy to bring the 2006 target closer and ensure inflation can feasibly reach the center of the target range for 2007. - Suggested principal instrument: higher interest rates—requiring an immediate increase of both the policy and the effective rates of at least 100 basis points. - Further increases might be necessary depending on exchange rate and wage developments and persistence of inflationary expectations. - Exchange rate and interventions: - Romania’s margin of competitiveness eroded, but exchange rate remains competitive; staff analysis showed Romania’s real exchange rate still undervalued. - Appreciation resulting from monetary tightening should be accommodated unless it leads to undershooting the inflation target. - FX market intervention should be sterilized fully at the policy rate and focused on reducing excess volatility rather than attempting to control longer-term trend. - NBR balance sheet concerns should not determine monetary policy conduct. - Developments after mission: - NBR announced a 100 basis-point increase in the policy rate to 8.5 percent. - Sterilization operations stepped up, bringing the effective rate in line with the policy rate. - Local currency appreciated by about 5 percent against the euro since the beginning of the year. - Implication: exchange rate channel likely stronger and interest-rate channel weaker due to high euroization and low household debt. ### Credit, prudential measures, and financial transmission - Prudential restrictions on credit flows had significant short-run impact on currency composition of lending: - From a peak of 5 percent of GDP in August 2005, the annualized flow of foreign-currency credit turned negative by end-December. - Local-currency flows almost doubled to 7 percent of GDP over the same period. - Total (annualized) credit flow dropped from about 9 percent of GDP in August to just above 5 percent of GDP in December. - Staff cautions and observations: - Effectiveness of administrative measures likely to diminish over time; demand for credit remains strong and market participants will seek alternate funding channels. - Some foreign-owned banks adapted by selling loan portfolios abroad or raising additional capital. - Restrictions on bank lending may encourage direct foreign borrowing by large corporates and favor less-regulated non-bank financial sector (NBFI). - Authorities have taken steps to bring NBFIs within regulatory scope: an emergency ordinance brought NBFIs under NBR regulation and supervision; new NBFI requirements anticipated to be fully effective by mid-2006. - Prudential-style measures should not substitute for traditional stabilization instruments; they should ensure risks associated with credit growth are adequately managed by lenders. - Using prudential measures in place of interest rates can have undesirable/unintended consequences and may fuel doubts about priority given to controlling inflation. ### Financial sector stability and development - Overall assessment: - Banking sector seems well-positioned to absorb adverse shocks, but authorities need to be alert to medium-term vulnerabilities. - Financial soundness indicators: relatively healthy and robust system; high rates of return on equity and capital-adequacy ratios; moderate NPL ratios. - NBR stress tests suggest resilience to direct impact of interest rate and exchange rate movements. - Indirect exposures through loan portfolios harder to assess—need high capital ratios and conservative provisioning. - As growth slows and loan portfolios mature, NPL ratios could increase significantly. - Progress and remaining priorities: - Substantial progress in strengthening regulatory and supervisory framework: - Implementation of many 2003 FSAP recommendations, including consolidated supervision, payment and settlement systems, extension of supervision to non-bank credit institutions, improved information exchange with foreign supervisors, tighter regulation of lending exposures, and establishment of a credit bureau. - Progress in developing capacity for assessing financial-system stability; publication of the first Financial Stability Report expected in April/May 2006. - Continued implementation of FSAP recommendations advised, including: - Improving accounting and audit practices in corporate and financial sectors. - Strengthening investor and creditor rights and judicial-system effectiveness. - Promoting increased information sharing through the credit bureau and closer monitoring of banks’ borrower assessment efforts. - Upgrading NBR’s risk-assessment capacity, especially in preparation for Basel II. - Consider issuing financial instruments to establish benchmark yields and promote domestic capital-market activity. ### Structural policies: privatization, energy, labor market, governance - Privatization: - Authorities acknowledged need to maintain momentum for privatization. - Recent sale of BCR noted as an important success to improve business climate and attract FDI. - Staff urged continuation of privatization of CEC, restructuring and privatization of the power generation sector (including Romgaz), and privatization of other smaller companies. - Energy sector and mining: - Authorities recognized need to continue energy price adjustments but hesitant to announce intentions. - Staff regretted gas prices not adjusted in line with opportunity costs. - Staff urged public announcement of schedule for increased domestic producer prices to achieve import parity over the medium term as per EU commitment. - Accelerating price convergence (allowing adequate adjustment time) would expedite enterprise restructuring. - Importance of implementing heating sector strategy and accelerating restructuring of the hard coal sector. - Progress in implementing mining sector strategy commended. - Labor market: - Consensus that a more flexible labor market is needed. - Romania stands out on costs of hiring and firing workers compared with peers. - Authorities noted recent amendments to the Labor Code expected to increase flexibility and participation by reducing hiring and firing costs (not incorporated in World Bank indicators). - Staff reservations on adequacy of these measures; urged further amendments to: - Increase employers’ representation in the Economic and Social Council. - Eliminate obligatory nature of collective wage contracts for non-signatory parties. - Governance: - Authorities determined to strengthen governance and improve business climate. - Business community highlighted difficulties using the judicial system; authorities considered rapid progress being made on judicial reform agenda. - Authorities pursuing liquidation of Rafo and effective implementation of improved bankruptcy proceedings approved last year. - Establishment of a National Anticorruption Prosecutor’s Office able to investigate and prosecute members of parliament. ### Program issues - Staff stated preparedness to engage in program discussions should authorities request resumption of SBA review discussions. - Context: - In June 2005 staff had reached understandings on completion of next SBA reviews, but political turmoil in July derailed implementation of key agreed policies. - Authorities expressed interest in resuming discussions to complete reviews of the SBA prior to its expiration in July 2006 and will engage staff on key conditionality for a Fund-supported program. ### Staff appraisal: outlook and policy prescription - Key judgments: - Romania at an important crossroad: convergence to EU continues and confidence remains high, but economic outlook clouded by widening imbalances. - Economic growth and disinflation have slowed; external imbalances widened. - Despite fiscal consolidation, domestic demand exacerbated by rapid credit growth and procyclical policies—substantial tax cuts and public-sector wage increases. - Policy prescription: - A tightening of policies is needed to resume disinflation, reduce external imbalances and vulnerabilities, and set stage for sustainable growth. - Emphasize enhancing productive capacity and designing macro policies prudently until real income growth is secured. - Higher foreign savings should boost investment and EU integration, but funds must be invested wisely to avoid excess private or government spending that could jeopardize stabilization goals. - Tighter fiscal and incomes policies will relieve some burden on monetary policy and minimize upward pressure on the exchange rate. - Failure to address widening imbalances may eventually lead to an adverse change in market sentiment. *Source: IMF staff report excerpt.* ### 42. A strong fiscal stance should be the centerpiece of the authorities’ strategy, ### A strong fiscal stance should be the centerpiece of the authorities’ strategy ### Fiscal stance and budget targets - Authorities should target a balanced budget for 2006 and small surpluses thereafter. - Meeting the government’s 2006 deficit target of 0.5 percent of GDP may again result in an unfortunate squeeze in capital expenditure without further measures. - Staff cautioned against utilizing privatization proceeds for higher spending that would increase the deficit and compromise macroeconomic objectives. - Fiscal sustainability is noted as not of immediate concern, but proactive fiscal posture is warranted given likely continued large capital inflows. ### Revenue strengthening and tax policy - The introduction of the flat tax resulted in a sizeable revenue loss. - Additional resources will be required for Romania’s contribution to the EU budget and co-financing of EU projects, and to allow for a much-needed boost in infrastructure spending. - High social contribution taxes impede employment; cuts in labor taxation will have to be offset by other taxes. - Well-designed revenue-raising measures should be approved now and take effect no later than January 2007 to provide stability in the tax code and avoid subsequent tinkering. - Important priorities: broaden the tax base and modernize fiscal administration. ### Medium-term fiscal framework and public spending management - Authorities should prepare an ambitious and transparent medium-term framework that: - Sets a realistic fiscal trajectory. - Fully incorporates the impact of ongoing reforms and post-accession flows. - Avoids surprises and improves budgetary controls. - Public spending management needs improvement to ensure a uniform pattern over the entire year and prevent sudden inflationary pressures. - Authorities need to assess the macroeconomic impact of large privatization proceeds and EU funds. - Essential to put in place mechanisms to ensure efficient allocation of resources and a high absorption rate for EU inflows. ### Public sector wage policy - Prudent public sector wage policy is critical for macroeconomic stability. - With large wage increases, inflation in Romania has been considerably higher than in all other European countries over the past 15 years. - Government wage policy needs recalibration for a low inflation economy, featuring wage increases only once a year. - The government’s decision to freeze all vacant positions in the general government (except EU accession-related hiring) is welcome, but vigilance is necessary to avoid wage overruns. - In staff’s view, the 2006 wage increases in the general government are not compatible with the NBR’s announced inflation target. - Authorities are commended for prudent decisions regarding the minimum wage and the wage bill of public enterprises. ### Monetary policy and exchange rate stance - The central bank should continue strengthening its inflation-targeting credentials. - The February increase in the policy interest rate by 100 basis points is an important first step, underscoring the primacy of inflation and helping bring inflation down to the center of the target range by end-2007. - Recent tightening of monetary policy is welcome, but further tightening might be necessary. - Although the exchange rate remains competitive, Romania’s margin of competitiveness has been eroded; productivity gains and prudent wage policies are needed to offset the impact of a strong currency. - Staff recommends that interventions in the foreign exchange market be fully sterilized and focused on reducing excess volatility, rather than controlling the longer-term trend. - With real appreciation likely as part of the income convergence process with the EU, it is preferable that this is achieved via the exchange rate rather than higher inflation. ### Financial sector resilience and supervision - Financial soundness indicators suggest a relatively healthy and robust financial system. - Stress tests suggest that the banking system would be resilient to the direct impact of interest rate and exchange rate movements. - Indirect exposures through loan portfolios are more difficult to assess and need to be reflected in capital ratios and conservative provisioning. - Authorities have made substantial progress strengthening the regulatory and supervisory framework; most of the recommendations contained in the 2003 FSAP have been implemented. - The NBR has made impressive progress in developing its capacity for assessing overall stability. - Staff commends regulation of nonbank financial institutions and encourages implementation of remaining FSAP recommendations. ### Structural reforms and competitiveness - An ambitious program of structural reform is needed to accelerate convergence to EU living standards and enhance competitiveness. - Recent progress on privatization is welcome; authorities are encouraged to maintain momentum with the privatization of CEC bank, Romgaz, and other smaller companies. - Labor market is more flexible following recent amendments to the Labor Code, but further amendments are needed to: - Eliminate the imposition of collective wage contracts for non-signatory parties. - Increase employers’ representation in the Economic and Social Council. - Legal framework has improved, but implementation challenges remain: reduce corruption, improve financial discipline, strengthen exit mechanisms for bankrupt enterprises, and enforce creditor rights. - Authorities are encouraged to publish the schedule for raising gas prices to import parity, and adjusting other energy prices in line with opportunity costs; delaying such adjustments will entail higher costs later on. - Continue progress on the government’s mining strategy. *Source: IMF staff report content (content unit: _cr06168 - 42). * ### 50. It is proposed that Romania’s Article IV consultation cycle remains subject to ### _cr06168 - 50. It is proposed that Romania’s Article IV consultation cycle remains subject to ### Article IV consultation cycle - It is proposed that Romania’s Article IV consultation cycle remains subject to the provisions of the decision on consultation cycles approved by the Board on July 15, 2002 (No. 12794-(02/76)). - Romania is on the 24-month consultation cycle. The last consultation was concluded on July 7, 2004. ### Macroeconomic performance and outlook (selected indicators) - Real GDP (change in percent): 2000: 2.1; 2001: 5.7; 2002: 5.1; 2003: 5.2; 2004: 8.4; 2005: 4.1; 2006 (Staff proj.): 5.2 - Final domestic demand (change in percent): 2000: 2.1; 2001: 7.0; 2002: 5.5; 2003: 8.3; 2004: 11.7; 2005: 9.4; 2006 (Proj.): 6.8 - CPI (end of period): 2000: 40.7; 2001: 30.3; 2002: 17.8; 2003: 14.1; 2004: 9.3; 2005: 8.6; 2006 (Proj.): 6.5 - Unemployment rate (end of period; percent): 2000: 10.5; 2001: 8.6; 2002: 8.4; 2003: 7.2; 2004: 6.2; 2005: 5.8; 2006 (Proj.): 5.7 - Gross national saving (percent of GDP): 2000: 15.8; 2001: 17.0; 2002: 18.3; 2003: 16.0; 2004: 13.9; 2005: 14.0; 2006 (Proj.): 15.7 - Gross domestic investment (percent of GDP): 2000: 19.5; 2001: 22.6; 2002: 21.7; 2003: 21.8; 2004: 22.3; 2005: 22.7; 2006 (Proj.): 24.2 ### Public finances (general government, percent of GDP) - Revenue: 2000: 31.2; 2001: 30.1; 2002: 29.6; 2003: 28.7; 2004: 30.1; 2005: 30.3; 2006 (Proj.): 31.3 - Expenditure: 2000: 35.3; 2001: 33.3; 2002: 32.3; 2003: 30.9; 2004: 31.1; 2005: 31.1; 2006 (Proj.): 31.3 - Overall balance: 2000: -4.0; 2001: -3.2; 2002: -2.6; 2003: -2.2; 2004: -1.0; 2005: -0.8; 2006 (Proj.): 0.0 - Primary balance: 2000: 0.9; 2001: 0.6; 2002: 0.4; 2003: -0.2; 2004: 0.2; 2005: 0.3; 2006 (Proj.): 1.0 - Total public debt (including domestic public debt and external public debt, public and publicly guaranteed): 2000: 27.8; 2001: 27.5; 2002: 25.9; 2003: 23.5; 2004: 22.4; 2005: 18.9; 2006 (Proj.): 16.7 ### External sector and reserves - Trade balance (percent of GDP): 2000: -4.5; 2001: -7.4; 2002: -5.7; 2003: -7.5; 2004: -8.8; 2005: -9.9; 2006 (Proj.): -10.3 - Current account balance (percent of GDP): 2000: -3.7; 2001: -5.5; 2002: -3.3; 2003: -5.8; 2004: -8.5; 2005: -8.7; 2006 (Proj.): -8.5 - External debt (percent of GDP): 2000: 29.8; 2001: 32.8; 2002: 32.8; 2003: 32.9; 2004: 35.1; 2005: 32.4; 2006 (Proj.): 32.4 - Official reserves (end-year, US$ million): 2000: 3,466; 2001: 5,168; 2002: 6,260; 2003: 7,143; 2004: 14,873; 2005: 22,866; 2006 (Proj.): 28,643 - Reserve cover (months of prospective imports, in € terms): 2000: 2.3; 2001: 3.5; 2002: 3.6; 2003: 2.8; 2004: 4.1; 2005: 5.6; 2006 (Proj.): 6.6 ### Monetary and financial indicators - Real domestic credit (end of year, percent change): 2000: 7.9; 2001: 28.0; 2002: 32.3; 2003: 56.9; 2004: 40.4; 2005: 44.7; 2006 (Proj.): 33.8 - Broad money (end of year, percent change): 2000: 38.0; 2001: 46.2; 2002: 38.2; 2003: 23.3; 2004: 40.1; 2005: 33.8; 2006 (Proj.): 24.3 - NBR interest rate (end of period): 2000: 60.1; 2001: 39.9; 2002: 21.5; 2003: 23.4; 2004: 18.8; 2005: 7.2; 2006 (last observation for February 2006) - Treasury bill rate (end of period): 2000: 59.4; 2001: 38.4; 2002: 17.4; 2003: 18.4; 2004: 11.5; 2005: 5.5 ### Balance of Payments (selected, in millions of euros) - Current account (levels): 2002: -1,623; 2003: -3,060; 2004: -5,099; 2005: -6,891; 2006 (Prel./Staff proj.): -8,098 - Ratio to annual GDP: 2002: -3.3; 2003: -5.8; 2004: -8.5; 2005: -8.7; 2006: -8.5 - Exports (levels): 2002: 14,675; 2003: 15,614; 2004: 18,935; 2005: 22,255; 2006: 24,484 - Imports (levels): 2002: -17,427; 2003: -19,569; 2004: -24,258; 2005: -30,061; 2006: -34,288 - Current account balance plus FDI (ratio to GDP): 2002: 0.2; 2003: -2.1; 2004: 0.0; 2005: -2.1; 2006: -1.0 - Capital account / Direct investment (levels): 2002 capital acccount: 4,799; 2003: 4,439; 2004: 9,111; 2005: 11,004; 2006: 13,756. Direct investment 2002: 1,515; 2003: 1,946; 2004: 5,127; 2005: 5,208; 2006: 7,149 ### Fiscal tables and medium-term fiscal stance - Consolidated general government: total revenue around 30.1–31.5 percent of GDP for 2004–06 (specific table entries: 2004 total revenue 30.1; 2005 approved 31.5; 2006 staff scenario 30.6) - Total expenditure around 31.1–32.0 percent of GDP for 2004–06 (2004: 31.1; 2005 approved: 33.6; 2006 staff scenario: 31.5) - Overall balance (percent of GDP): 2004: -1.0; 2005: -0.8; 2006 (Staff scenario): -0.5 - Staff medium-term projections (Table 4): Overall Balance (percent of GDP) for 2007–11 shows values including -1.3 (2007), -0.5 (2008), 0.0 (2009), -1.0 (2010), 0.2 (2011) ### Banking sector and financial soundness - Number of banks: 2003: 38; 2004: 39; 2005: 39 - Capital Adequacy CAR: 2003: 20.0; 2004: 18.8; 2005: 20.2 - NPLs/Gross Loans: 2003: 8.3; 2004: 8.1; 2005: 8.3 - Return on Average Assets: 2003: 2.7; 2004: 2.5; 2005: 1.9 - Foreign currency denominated loans/total loans: 2003: 56.4; 2004: 61.5; 2005: 54.4 ### Fund relations, program, and technical assistance (Appendix I) - Membership: Joined 12/15/72; Article VIII - Quota: 1,030.20 (SDR million) = 100.00 percent of quota - Outstanding purchases and loans: Stand-By Arrangements: 161.89 (SDR million) = 15.71 percent of quota (as of February 28, 2006) - Financial arrangements history: Stand-By approvals listed with dates and amounts (examples): 07/07/04 approval 250.00 (SDR million); 10/31/01 approval 300.00 (SDR million), drawn 300.00. - Projected payments to the Fund (Expectations Basis): Principal 2006: 93.00; 2007: 68.89. Charges/interest schedule includes 6.14 and 4.31, 2.58 entries as shown in the table. - Exchange rate arrangements: De jure inflation-targeting regime since August 2005; exchange-rate approach characterized as a managed float. Romania accepted Article VIII obligations effective March 25, 1998. - Technical assistance: More than 40 technical assistance missions since 1990; assistance areas include fiscal reforms, central bank and banking system modernization, legal structure, training, and statistics. Tax administration reform implementation started January 2003. ROSC on fiscal transparency completed November 6, 2002. FSAP completed in 2003. Technical assistance on inflation targeting ongoing. - Safeguards assessment: Completed June 17, 2004; safeguards at NBR appear generally adequate; weaknesses in internal audit and control system were identified and measures to address them have been reported implemented. - AML/CFT framework: Legislative updates to align with international standards in context of EU accession; severe shortcomings remain in supervision outside banking sector and in oversight of non-financial sector; additional training of reporting entities and competent authorities remains necessary. - Resident representative: Fund resident representative in Bucharest since 1991; Mr. Graeme Justice assumed post in January 2003. *Sources: Romanian authorities; and Fund staff estimates and projections.* ### 1. The Romanian authorities are pursuing a strategy designed to achieve macroeconomic ### _cr06168 - 1. The Romanian authorities are pursuing a strategy designed to achieve macroeconomic ### Macroeconomic strategy and reform priorities - Objectives: - Achieve macroeconomic stability. - Establish sustainable economic growth and poverty reduction. - Move towards eventual accession to the European Union. - Key policy elements: - Tightening payments discipline throughout the economy, especially in the energy sector. - Hardening budget constraints for state-owned enterprises. - Actively pursuing enterprise and banking privatization and restructuring. - Strengthening the social safety net. - Governance and private sector development reforms emphasized as critical for continued recovery: - Transparency and accountability in government. - Judicial reforms. - Improvements in the business environment. - Strengthening regulation and oversight of financial and capital markets. - Medium-term condition: continuation of the current economic recovery depends critically on maintenance of reform momentum and steady progress on governance and private sector reforms. ### IMF role, program focus, and instruments - IMF lead areas: - Fiscal framework. - Monetary policy. - Structural reform elements with direct bearing on the macroeconomic situation. - Main IMF program vehicles: - Previous Stand-By Arrangement (SBA) covering the period October 31, 2001 to October 15, 2003. - The current precautionary SBA. - IMF responsibilities (areas without direct World Bank involvement): - Dialogue on monetary policy, interest rates, the exchange rate regime, the balance of payments, and related statistical and measurement issues. ### World Bank role, program focus, and instruments - Bank lead areas (structural issues and poverty reduction): - Poverty reduction measures, private sector development, institution building and governance. - Bank instruments and operations mentioned: - PSAL 1 and PSAL 2. - Series of Programmatic Adjustment Loans (PAL), first of which went to the Bank Board in September 2004. - Employment and Social Protection Loan, Social Sector Development Loan, Social Development Fund, Mine Closure Loan. - Public Expenditure and Institutions Review (PEIR), Country Economic Memorandum (CEM). - Private and Public Sector Institution Building Loan (PPIBL) providing $18.6 million for technical assistance. - Rural Finance Loan, Irrigation Rehabilitation loan. - Cadastral and land titling project, environmental mine closure project, hazards mitigation project cofinanced by a GEF grant, regional Trade and Transportation Facilitation in South East Europe project. - Areas of Bank-led policy dialogue without direct IMF involvement: - Strengthening the social safety net (poverty monitoring, social assistance, pension reform, child welfare reform, health sector reforms, labor retraining and redeployment). - Revitalizing rural economies and rural infrastructure and governance. - Institution building and governance, fiscal decentralization, budget process reforms, anti-corruption diagnostics and prevention. - Business environment reforms (reducing barriers to entry, accounting standards, bankruptcy and liquidation procedures). ### Areas of shared responsibility and coordination - Shared interests and coordination: - Close collaborative relationship between IMF and World Bank staff in support of Government reform program. - Bank analysis often used as input for the IMF fiscal framework; certain Bank-led structural reforms with fiscal implications are reflected in IMF conditionality (e.g., energy sector reform and restructuring). - Formal joint responsibility example: Financial Sector Assessment Program (FSAP), jointly conducted and completed in June 2003. - Specific shared areas: - Privatization and restructuring of large SOEs, especially where privatization revenues and quasi-fiscal deficits affect macroeconomic stability. - Energy sector reforms (tariff setting, arrears clearance, collection rates, power generation restructuring, regional electricity market integration, regulatory and market operation issues). - Banking sector restructuring, privatization, and liquidation (Law on Bank Privatization modifications under PSAL 1; liquidation of Bancorex; restructuring and privatization of Bank Agricola; continued steps to privatize the Savings Bank (CEC)). ### Bank-led privatization and energy/banking sector programs that inform IMF programs - Privatization program elements: - PAL program includes targets and timelines for privatization of commercial SOEs and financial institutions; builds on PSALs 1 and 2. - Specific enterprises identified earlier include Alro, Alprom, and Petrom. - Emphasis on clear, open and transparent tender processes using qualified investment advisors consistent with Bank policies. - Energy sector engagement: - Bank support for energy tariff reforms and reforms in electricity, district heating and gas sectors. - Bank leads IFI dialogue on power generation restructuring, integration with the South East European Regional Electricity Market and the EU electricity market. - Technical assistance to the Ministry of Industry on gas pricing and taxation to attract investment. - Ongoing dialogue on the Energy and Infrastructure Strategy paper and its operational recommendations. - Banking and financial sector engagement: - Under PSAL 1: modification of the Law on Bank Privatization; tightened NBR liquidity and solvency requirements; improved compliance with prudential regulations and external audits per International Accounting Standards; introduction of legal/institutional reforms for disposition of non-performing assets. - Continued dialogue on improving legal and regulatory framework for securities and insurance sectors; PPIBL support for these activities. ### World Bank Group strategy, lending operations, and portfolio (high-level figures and scenarios) - Last CAS presented to Bank Board on June 19, 2001; lending/advisory based on Government priorities of poverty reduction and EU accession. - Two CAS lending scenarios (FY02–04): - Low case: Bank Group support reduced to $60 million during FY02–04, focused on a few poverty interventions. - High case: Bank commitments of up to $995 million during FY02–04 (compared with $600 million in FY98–00), conditional on fulfillment of high-case triggers. - High-case triggers included: - Progress in establishing a macroeconomic environment conducive to lower inflation and sustainable growth. - Progress on structural issues including privatization initiated under PSAL program. - Initiation of privatization and work-out for remaining large SOEs. - Agreement on plan and schedule for reducing energy arrears. - Agreement on method and timetable for privatization of Romanian Commercial Bank and the Savings Bank. - Improvements in financial sector legal and supervisory framework. - Agreement on an anti-corruption strategy. - Approval of social assistance legislation. - PALs and PSAL chronology: - PSAL 2 approved by the Bank Board in September 2002. - PEIR delivered in July 2002. - First PAL approved by the Board in September 2004; closed successfully March 31, 2005. - PAL 1 Program Document included a CAS Update covering FY05; FY05 program continued two distinct lending scenarios with high-case maintenance conditions (listed below). - FY05 high-case continuation conditions (selected): - (i) maintenance of a macroeconomic framework agreeable to the Bank; - (ii) sustained progress in PAL 1 actions; - (iii) adherence to agreed schedules of electricity and gas price increases; - (iv) sustained progress, satisfactory to the Bank on the sale of Petrom and two electricity distribution companies as well as privatization of AVAS companies; - (v) observance of agreed pension deficit ceiling; - (vi) timely initiation and completion of planned technical assistance activities under the PPIPL supporting judicial and public administration reforms. - Next full CAS timing: - To be discussed at the Board in the spring of 2006 after Bank management’s assessment of Romania’s macroeconomic framework. - World Bank activity and portfolio figures: - World Bank active in Romania since 1991. - Portfolio built to 51 Bank-financed operations with total commitments of US$4.9 billion. - Romania's portfolio: largest in ECA in terms of number of projects and third largest in commitments. - Active portfolio as of January 3, 2006: 23 projects with aggregate net commitments totaling $1.6 billion and a total undisbursed balance of $1 billion. - Sector composition (net commitments): environment and socially sustainable development 48 percent (eleven projects); energy and infrastructure 22 percent (five projects); social sectors 17 percent (four projects). - Portfolio quality and implementation issues: - Quality improving, but cross-cutting implementation issues persist: - Project management capacity (procedures, inter-agency coordination, project implementation unit staffing and facilities). - Imposition of ceilings to withdrawals from external borrowing to restrain public expenditures and protect the budget deficit target; timely availability of counterpart contributions; quality and processing of disbursement applications. - Integration of procurement planning into the financial budgeting process. - IFC activity: - IFC commitments to date: over US$712 million of its own funds in 37 projects; arranged over $241 million in syndications. - IFC portfolio as of December 2005: $525 million. - IFC advisory assignments supporting privatization and restructuring of large SOEs, public utilities and the health sector. ### Statistical issues and data quality - General assessment: - Data collection and reporting adequate for surveillance and program monitoring, but quality of national accounts, price, fiscal, and balance-of-payments data needs improvement. - Authorities have made progress with technical assistance, including from the Fund. - Romania began participating in the GDDS in February 2001 and graduated to subscription to the SDDS in May 2005. - Real sector statistics: - Quarterly and annual national accounts produced by the National Institute for Statistics (INS) using ESA95. - Estimates are methodologically sound and reported to the Fund on a timely basis for IFS publication. - Quarterly and annual national accounts are not harmonized on a regular basis and late revisions can sometimes be significant. - Latest dedicated national accounts publication released in October 2005 and included final accounts for the 1999-2002 series. - Provisional and semi-final versions disseminated in the Statistical Yearbook and other publications, and on the web at (www.insse.ro). - Price statistics: - Consumer Price Index (CPI) subject to standard annual re-weighting and considered reliable. - In January 2004, the INS changed the coverage of the PPI to include the domestic and non-domestic markets. *Document: _cr06168 - 1. The Romanian authorities are pursuing a strategy designed to achieve macroeconomic* ### 4. Consolidated data on central government operations are reported annually for the ### _cr06168 - 4. Consolidated data on central government operations are reported annually for the ### Consolidated central government and general government data - Consolidated data on central government operations are reported annually for the GFS Yearbook and quarterly for IFS; EUR receives monthly budget data. - Consolidated general government data have been reported for inclusion in the 2005 GFS Yearbook. - Reporting basis and adjustments: - Data are reported on an accrual basis, derived from cash data using various methods. - Tax revenues are adjusted using the time-adjusted cash method. - Expense data are adjusted using due-for-payments data. - Interest payments are calculated on an accrual basis. - Institutional changes affecting reporting: - Beginning in 2002, the Special Fund for Development of the Energy System, Special Fund for Public Roads, Special Fund “Romanian Agriculture Development,” and Special Fund “Romania” were included in the state budget. - The Special Fund for Insured Protection was eliminated from general government accounts. - The reported data excluded data on the Agency for Recovery Bank Assets. - Classification and historical coverage: - The authorities introduced a new budget classification for the 2006 budget and have produced the 2004-05 outturns on the basis of the new classification. - Fiscal accounts have not been produced for years prior to 2004. ### Monetary and financial statistics - The NBR reports monetary and financial statistics regularly and timely for publication in the IFS. - Since December 2004, the NBR reports monetary data to STA using the Standardized Report Forms (SRFs) designed in accordance with the Monetary and Financial Statistics Manual methodology. - Data reconciliation note: - Monetary statistics need to be reconciled with government finance statistics. - In line with 1993 SNA and MFSM, accrued interest on deposits and loans, and securities other than shares should be incorporated in the outstanding amount of financial assets or liquidity. ### Balance of payments statistics - The NBR routinely reports balance of payments statistics to the Fund in a timely fashion. - A 2003 STA mission reviewed the NBR’s compilation methodology for balance of payments and international investment position statistics (developed in consultation with Eurostat) and concluded the proposed system is broadly appropriate. - The STA mission supported implementation of this compilation system in 2004, along with a new FDI survey. ### Table of common indicators (selected entries, as of February 28, 2006) - Exchange Rates: Date of latest observation Feb.2006; Date received Feb.2006; Frequency of Data D and M; Frequency of Reporting D and M; Frequency of Publication D and M. - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation Feb. 2006; Date received Feb. 2006; Frequency of Data D and M; Frequency of Reporting W and M; Frequency of Publication M. - Reserve/Base Money: Date of latest observation Jan.2005; Date received Feb 2006; Frequency of Data D and M; Frequency of Reporting W and M; Frequency of Publication M. - Broad Money, Central Bank Balance Sheet, Consolidated Balance Sheet of the Banking System: Date of latest observation Jan. 2005; Date received Feb. 2006; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - Interest Rates: Date of latest observation Dec. 2005; Date received Feb. 2006; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - Consumer Price Index: Date of latest observation Jan. 2006; Date received Feb. 2006; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - Revenue, Expenditure, Balance and Composition of Financing – General Government: Date of latest observation Jan. 2006; Date received Feb. 2006; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - Stocks of Central Government and Central Government-Guaranteed Debt: Date of latest observation Dec. 2006; Date received Feb. 2006; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - External Current Account Balance: Date of latest observation Dec. 2005; Date received Feb. 2006; Frequency of Data M; Frequency of Reporting Q; Frequency of Publication Q. - GDP/GNP: Date of latest observation Q3 2005; Date received Dec. 2005; Frequency of Data Q; Frequency of Reporting Q; Frequency of Publication Q. ### External debt sustainability — baseline findings and projections (A. External Sustainability) - Baseline projection: external debt-to-GDP ratio is expected to increase slightly to about 35 percent over the medium-term. - Main driver: slowdown of non-debt creating flows from the current level of 7-8 percent of GDP to about 4¼ percent of GDP by 2010-11. - Gross external financing needs: projected to remain stable at 14½ percent of GDP throughout the projection period, reflecting a slight increase in debt service that offsets the current account improvement. - Stress test results: - The external debt is most vulnerable to a further widening of the current account deficit (B3): an average 1 percent of GDP widening of the current account deficit would result in a debt-to-GDP ratio of 40 percent over the medium-term. - Under other standard shocks, external debt dynamics would remain under control (a ratio below 40 percent of GDP) though increasing over the medium term. - A sharp real depreciation could increase the debt-to-GDP ratio above 46 percent on impact; the ratio would return to a 35-40 percent range by the end of the projection period. - Numeric trajectory (selected baseline series from Table 12): - External debt: 32.4 (2006), 31.3 (2007), 32.2 (2008), 33.4 (2009), 34.0 (2010), 35.2 (2011). - Identified external debt-creating flows (4+8+9) for 2006–2011 include values such as -3.5 (2006), -2.3 (2007), -0.1 (2008), 0.1 (2009), 0.0 (2010), -0.1 (2011). - Current account deficit, excluding interest payments: 7.7 (2006), 7.6 (2007), 7.5 (2008), 7.5 (2009), 7.3 (2010), 6.8 (2011) — all in percent of GDP. - Gross external financing need (in billions of US dollars): 16.7 (2006), 19.7 (2007), 22.1 (2008), 25.3 (2009), 28.3 (2010), 31.6 (2011). - Gross external financing need (in percent of GDP): 14.1 (2004 historical indicator noted), 14.2 (2005), 14.7 (historical average shown elsewhere in table). - Key macroeconomic assumptions (baseline averages/projections shown in Table 12): - Real GDP growth (projected averages): 2.3 (2006), 4.8 (2007), 5.2 (2008), 5.6 (2009), 5.6 (2010), 5.6 (2011). - Exchange rate appreciation (US dollar value of local currency, period average): -20.6 (2006), 21.4 (2007), -0.8 (2008), 7.0 (2009), 2.5 (2010), 2.2 (2011). - Nominal external interest rate (in percent): 4.4 (2006), 0.8 (2007), 2.8 (2008), 2.5 (2009), 2.3 (2010), 2.0 (2011). ### Public debt sustainability — baseline findings and projections (B. Fiscal Sustainability) - Baseline fiscal path: - Public sector debt is expected to remain under control over the medium-term. - Primary surpluses would remain stable at about 1 percent of GDP. - Overall fiscal balances would hinge at around ¼ percent of GDP over the medium-term. - This path would lead to a fall in public sector debt from the current level of 19 percent of GDP to about 14 percent of GDP by 2010-11. - A primary deficit of ¾ percent of GDP would stabilize public debt at this level. - Vulnerabilities from stress tests: - Fiscal sustainability remains vulnerable to real GDP growth shocks: - If GDP growth slows by about 2¼ percentage points to 3½ percent over the medium-term, public debt would climb to about 30 percent of GDP. - Dynamics are resilient to shocks in nominal interest rate, real exchange rate, and primary balance, with the debt ratio remaining below 25 percent of GDP throughout the period under those shocks. - Numeric trajectory (selected baseline series from Table 13): - Public sector debt: 16.7 (2006), 15.3 (2007), 15.1 (2008), 15.0 (2009), 14.7 (2010), 14.4 (2011). - Change in public sector debt: -2.2 (2006), -1.4 (2007), -0.1 (2008), -0.2 (2009), -0.2 (2010), -0.3 (2011). - Primary deficit (percent of GDP): 0.1 (2006), 1.3 (2007), -1.0 (2008), -1.2 (2009), -1.1 (2010), -1.0 (2011) — as reported in the projections section. - Public sector debt-to-revenue ratio: 53.3 (2006), 48.3 (2007), 47.9 (2008), 47.1 (2009), 46.1 (2010), 45.1 (2011). - Gross financing need (percent of GDP): 4.1 (2006), 3.8 (2007), 4.0 (2008), 3.3 (2009), 3.6 (2010), 3.1 (2011). - Stress-test scenarios (selected outcomes from Table 13): - A1 (key variables at historical averages in 2006-11): public sector debt path shows values such as 18.4, 18.8, 20.5, 22.1, 23.6, 25.1 (table rows for debt-stabilizing primary balance). - B1–B4 bound tests include scenarios for lower growth, worse primary balance, one-time 30 percent real depreciation in 2006, and increases in nominal interest rates, with resulting shifts in debt-stabilizing primary balance and public debt indicators shown in the table. ### Policy-relevant conclusions and implications (drawn from findings in the text) - Maintain policies to contain domestic demand (lower consumption and import growth) to preserve external sustainability, since current account widening materially affects external debt dynamics. - Preserve primary surpluses around 1 percent of GDP and overall balances near ¼ percent of GDP to keep public sector debt on a declining path toward about 14 percent of GDP by 2010-11. - Monitor vulnerabilities to growth shocks and exchange rate shocks; be prepared for contingency measures if real GDP growth slows or a sharp real depreciation occurs, given potential for substantial increases in debt ratios under those shocks. - Improve reconciliation between monetary statistics and government finance statistics, and continue implementation of standardized reporting (SRFs) and balance of payments methodological enhancements supported by STA. *Source: _cr06168 - 4. Consolidated data on central government operations are reported annually for the* ### 1. This statement provides information on recent developments since the issuance of the ### This statement provides information on recent developments since the issuance of the staff report ### Recent developments and overarching assessment - The new information does not change the thrust of the staff appraisal and reinforces the staff’s concerns about the current policy mix which places a heavy burden on monetary policy to achieve the authorities’ macroeconomic objectives. - Authorities confirmed their intention not to resume discussions for the completion of reviews under the SBA prior to its expiration in July 2006. - The authorities and staff broadly agree on the need to address imbalances, but differ on the magnitude of needed adjustments. The authorities are confident the envisaged policy mix is adequate to preserve macrostability and sustain strong growth. ### Fiscal developments - On April 19 the government approved a revised 2006 budget, increasing the deficit from 0.5 to 0.9 percent of GDP. - The approved budget includes additional allocations equivalent to 1 percent of GDP for infrastructure, teachers’ wages, social benefits, flood repairs, and other expenditure. - The additional expenditure will be partially financed by higher-than-originally-budgeted revenue (estimated by the authorities at 0.6 percent of GDP), associated mainly with strong indirect tax collections due to the continued consumption boom, and initially-conservative revenue projections. - The government approved (already-budgeted) hikes in excises effective July 1, 2006 in line with Romania’s commitments to the EU; and additional excises on tobacco and alcohol, effective immediately. - The staff’s view (¶20 of the staff report) is that the underlying budget deficit for 2006 is about 1 percent of GDP. - The Senate approved legislation that could increase the general government deficit relative to the revised budget: a cut in the VAT rate on food to 9 percent (from the current 19 percent), with an estimated revenue loss of 3⁄4 percent of GDP. If approved by the House, this would weaken government revenue and increase the budget deficit. The government indicated it will not support such legislation and would adopt offsetting revenue-raising measures if it passes. - Executive Directors expressed concern about the government’s decision to increase the 2006 deficit target and emphasized that fiscal consolidation will be essential to containing domestic demand, making room for capital inflows, and ensuring sustainability over the medium term. - Directors recommended revenue-raising measures to strengthen revenue permanently, broaden the tax base, modernize fiscal administration, and make room for needed higher expenditures (including EU contributions and co-financing). ### External imbalances and the current account - Staff projects a widening in the current account deficit to about 9 percent of GDP in part on account of the envisaged fiscal loosening. - Recent data confirm widening macroeconomic imbalances: the consumption boom continues, strong import growth outpaces export growth, and the current account deficit is widening. - The staff report’s earlier projected narrowing of the current account deficit (which incorporated a change in the policy mix as recommended by Fund staff) was driven by an improvement in the savings-investment balance of the government, allowing for a substantial increase in private sector investment. - Directors noted that reducing the external imbalance will be crucial for removing Romania’s external vulnerability and urged policies to ensure the growth-enhancing use of large capital inflows. - Directors urged a coherent plan for absorbing prospective large inflows to the public accounts from EU funds and for saving privatization proceeds, to avoid generating excess demand pressures. ### Monetary policy and exchange rate - The monetary authorities affirmed readiness to tighten policy further depending on the evolution of inflationary pressures. - Following the increase in the policy interest rate in February, the authorities stepped up open-market operations and brought the effective sterilization rate in line with the policy rate—this stance was maintained through April. - The envisaged fiscal loosening and the inflationary consequences of higher excise rates on tobacco and alcohol have created a more challenging environment for the National Bank. - Background: In February 2006, the NBR increased its policy rate from 7.5 to 8.5 percent and stepped up sterilization operations to bring the effective rate in line with the policy rate. This generated renewed pressure on the currency, which appreciated by about 4¼ percent against the euro from end-2005 to end-March 2006. - Directors welcomed the recent tightening of monetary policy and viewed that further tightening might be necessary, in light of the envisaged fiscal loosening and higher excise rates. - Directors noted interventions in the foreign exchange market should be fully sterilized and focused on reducing excess volatility rather than controlling the longer-term trend. ### Structural reforms and financial sector - Mixed progress on structural reforms: successes include large-scale privatization (including BCR), continued liberalization of electricity and gas markets, increased national reference price for heating, and progress on the mining strategy. - Outstanding issues: gas prices not adjusted in line with opportunity costs (domestic producer price is only 38 percent of the international import price); remaining labor market rigidities; need for further judicial reform and anti-corruption measures. - Directors encouraged continuing privatization (Savings Bank, Romgaz, and smaller companies), further amendments to the Labor Code to increase flexibility, improvements in the legal framework to reduce corruption, improve financial discipline, strengthen exit mechanisms for bankrupt enterprises, and enforce creditor rights; and adjusting energy prices in line with opportunity costs. - Financial soundness indicators suggest a relatively healthy and robust financial system; stress tests indicate resilience to direct impacts of interest rate and exchange rate movements. However, Directors stressed that medium-term vulnerabilities from escalating bank credit to the private sector—much of it in foreign currency and to unhedged households—need close monitoring. ### Key statistics and projections (selected, as presented) - Growth: Real GDP change (percent) — 2004: 8.4; 2005: 4.1; 2006 (Staff Proj. 1/): 5.2 - Final domestic demand (change in percent) — 2004: 11.7; 2005: 9.4; 2006: 6.8 - CPI (end of period): 2004: 9.3; 2005: 8.6; 2006: 6.5 - CPI (period average): 2004: 11.9; 2005: 9.0; 2006: 7.9 - Unemployment rate (end of period; percent): 2004: 6.2; 2005: 5.8; 2006: 5.7 - Gross national saving (percent of GDP): 2004: 13.9; 2005: 14.0; 2006: 15.7 - Gross domestic investment (percent of GDP): 2004: 22.3; 2005: 22.7; 2006: 24.2 - Public finance (general government, percent of GDP) — Revenue: 2004: 30.1; 2005: 30.3; 2006: 31.3 - Expenditure: 2004: 31.1; 2005: 31.1; 2006: 31.3 - Overall balance (percent of GDP): 2004: -1.0; 2005: -0.8; 2006: 0.0 - Primary balance (percent of GDP): 2004: 0.2; 2005: 0.3; 2006: 1.0 - Total public debt: 2004: 23.1; 2005: 18.9; 2006: 16.7 - Real domestic credit (end of year, percent change): 2004: 40.4; 2005: 44.7; 2006: 33.8 - Broad money (end of year, percent change): 2004: 40.1; 2005: 33.8; 2006: 24.3 - NBR interest rate (end of period): 2004: 18.8; 2005: 7.2; 2006: 8.5 (last observation is for February, 2006) - Trade balance (percent of GDP): 2004: -8.8; 2005: -9.9; 2006: -10.3 - Current account balance (percent of GDP): 2004: -8.5; 2005: -8.7; 2006: -8.5 - External debt (percent of GDP): 2004: 36.3; 2005: 32.4; 2006: 32.4 - Official reserves (end-year, US$ million): 2002: 6,260; 2003: 7,143; 2004: 14,873; 2005: 22,866; 2006: 28,643 - Reserve cover (months of prospective imports, in € terms): 2002: 3.6; 2003: 2.8; 2004: 4.1; 2005: 5.6; 2006: 6.6 - Lei per Euro (end of period): 2004: 3.96; 2005: 3.68; 2006: 3.48 (in RON, actual as of February 28, 2006) - Lei per US$ (end of period): 2004: 2.91; 2005: 3.11; 2006: 2.94 (in RON, actual as of February 28, 2006) - Social indicators (reference year): Per capita GDP (2005): $4445; income distribution (GINI coefficient, 2000): 30.3; Poverty rate (2002): 18 percent; primary education completion rate (2002): 94 percent; gender pay gap (2003): 18 percent; Life expectancy at birth (2003): 74.9; infant mortality per 1000 live births (2002): 19 ### Policy recommendations and priorities highlighted by Directors - Re-establish fiscal consolidation to contain domestic demand and reduce external vulnerability. - Adopt revenue-raising measures to strengthen revenue permanently, broaden the tax base, modernize fiscal administration, and make room for needed higher expenditures (including EU obligations and infrastructure). - Develop a coherent plan for absorbing EU fund inflows and saving privatization proceeds to avoid excess demand pressures. - Maintain a prudent public sector wage policy; restrict wage increases to the needs of a low inflation economy and limit wage overruns. - Continue strengthening the NBR’s inflation-targeting credibility; be prepared to tighten monetary policy further if warranted. - Ensure foreign exchange interventions are fully sterilized and focus on reducing excess volatility rather than controlling the longer-term trend. - Accelerate structural reforms: privatization, labor market amendments to increase flexibility, legal reforms to reduce corruption, improve financial discipline, strengthen exit mechanisms, enforce creditor rights, and adjust energy prices in line with opportunity costs. - Monitor and address financial sector vulnerabilities arising from rapid credit growth, large foreign currency exposures, and unhedged household borrowing. *Source: IMF staff report and Public Information Notice (PIN) No. 06/49, May 4, 2006; IMF Executive Board conclusions of the 2006 Article IV consultation with Romania; statement by Jeroen Kremers and Lucian Croitoru, April 26, 2006.* ### 2005. These inflows increased after the capital account was liberalized in April 2005, as part ### _cr06168 - 2005. These inflows increased after the capital account was liberalized in April 2005, as part ### Macroeconomic developments and external sector - Capital account liberalized in April 2005 as part of the authorities’ EU commitments; inflows increased and led to a significant leu appreciation. - NBR reduced its effective interest rate for sterilization to below the headline policy interest rate soon after shifting to inflation targeting in August 2005; this monetary relaxation was partly reversed later in the year. - Contributing factors to sharp increase in private consumption: lower taxes adopted in January 2005, higher wages, and faster credit growth. - CPI disinflation slowed, reaching 8.6 percent y/y in December 2005 and 8.4 percent y/y in March this year. - Footnotes in source: December 2005 outcome against NBR’s target of 7.5 percent ±1 percent band at end-2005 and an outcome of 9.3 percent in December 2004; March outcome against NBR’s target of 5 percent ±1 percent band at end-2006. - Current account deficit: 8.5 percent of GDP in 2004 and 8.7 percent of GDP in 2005. - EU grants and FDI covered 90 percent of the current account; private capital inflows financed the rest and supported a reserve accumulation of almost $ 8 billion in 2005. - Fiscal consolidation: general government deficit kept to 0.8 percent of GDP in 2005—below the target of 1 percent of GDP and below a deficit of 1 percent of GDP in 2004. - Financial system described as healthy and robust, well positioned to absorb adverse shocks. - Structural reform progress: continued privatization in banking (sale of BCR), privatization and deregulation of gas and electricity, progress on mining sector strategy. - Gas prices remained at 38 percent of the international import prices; gap to be eliminated by the end of 2008 as agreed with the EU. ### Policy stance and outlook - Authorities committed to preserving macroeconomic stability and renewing reform efforts as prerequisites for sustained strong growth. - To contain external imbalances and advance disinflation, authorities intend to further tighten macroeconomic policies: tight budget deficit and tight incomes policy in 2006 to aid monetary policy and reduce pressure for currency appreciation. - Fiscal deficit for 2006 envisaged at 0.9 percent of GDP (roughly the same as 2005 outcome); this is a small increase relative to the year’s original budget (which incorporated a 0.5 percent deficit) to accommodate extra room for investment in infrastructure, education, and flood defense. - Authorities consider the exchange rate competitive despite recent sharp leu appreciation and indicate a moderate further appreciation could be accommodated. - Authorities to improve project-implementation capacity to absorb EU funds and increase share of capital spending in the public budget; commit to improving investment climate, harmonizing institutional framework with EU standards, and continuing privatization and enterprise restructuring. ### Fiscal policy - Fiscal policy to play a central role in preserving macroeconomic stability; Romania’s low public debt implies fiscal sustainability is not a concern, but prudent fiscal policy and tight incomes policy are needed to address excess demand from large capital inflows. - Authorities assess that a 0.9 percent deficit is appropriate, noting tax cuts and wage hikes that fueled consumption in prior year would not be repeated. - Revenue strengthening emphasized due to limits on expenditure compression (recent compression resulted in arrears). Government cleared health sector arrears last year and aims to avoid further arrears accumulation. - Additional revenue needed to: compensate further cuts in the social contribution tax, provide resources for Romania’s contributions to the EU budget and co-financing of EU projects, and meet modern infrastructure needs. - Comprehensive revision of the fiscal code ongoing; draft to be submitted to Parliament in June this year. Measures envisaged to raise revenue include increases in taxes on buildings, land, and transportation means, adoption of new taxes on tobacco and alcohol. - Plan to improve tax collection and tax administration in line with FAD and World Bank recommendations. - Change to micro-enterprises taxation system as of January 2007 to bring these enterprises under the regular corporate income tax, expected to bring additional revenue of about 0.6 percent of GDP. - Royalty increases envisaged for water, oil, salt, and sand. - Anticipated privatization proceeds and EU transfers: privatization inflows in 2006 expected to be about 3 percent of GDP; post-accession EU receipts will exceed 2 percent of GDP in the first year of accession. - Government finishing a medium-term budgetary framework fully incorporating these funds and post-accession expenditure; plan to continue placing revenue from privatization with the NBR, which invests it abroad. - Authorities working on mechanisms to ensure efficient allocation and absorption of EU inflows; with World Bank assistance, working to improve quality of public expenditure, overhauling pay and employment practices, improving health services quality, and introducing a second pension pillar. ### Wage policy - Wage policy aimed at managing demand pressures and protecting competitiveness. - For 2006: agreed prudent annual increase of 6.5 percent in the statutory minimum wage. - Increase in the wage bill of SOEs monitored under the SBA to be limited to 3.5 percent. - Authorities decided to freeze all vacant positions in the general government to offset wage overruns and will monitor wage developments closely; may cancel bonuses if necessary. - Commitment to one wage increase per year starting in 2007 to terminate interim ad hoc increases. ### Monetary policy and credit conditions - NBR strongly committed to inflation targeting; missed last year’s target by 0.1 percentage points in a difficult environment. - Faced with strong capital inflows at adoption of inflation targeting, NBR intervened heavily in foreign exchange market and cut interest rates to alleviate abrupt leu appreciation; this arrest of short-term pressures came at cost of temporary easing and slightly missing the inflation target. - Authorities decided to maintain inflation targets for 2006 and 2007, while acknowledging the 2006 target might be difficult to reach and a strong action plan is needed to achieve the 4-percent target by the end of 2007. - Planned increases in administered prices expected to contribute 21⁄2-3 percentage point to headline inflation. - NBR tightened policy in 2006: resumed full sterilization at the policy interest rate in November 2005 and increased the policy interest rate by 100 basis points to 8.5 percent in February this year to signal primacy of inflation. - Monetary tightening added pressures on the leu, which appreciated by about 5 percent against the euro since the beginning of the year. Further tightening may follow depending on inflationary pressures. - Credit growth moderated but authorities remain cautious; administrative prudential restrictions adopted in July-August 2005 to tame foreign-currency lending. - Monetary easing in 2005 narrowed gap between local and foreign-currency interest rates, shifting composition of lending and decelerating overall lending: - Annualized flow of foreign-currency credit reached a peak of 5 percent of GDP in August 2005, turned negative in December. - Local-currency flows almost doubled to 7 percent of GDP over the same period. - Total annualized credit flow dropped from about 9 percent of GDP in August to roughly 5 percent of GDP in December 2005. - Authorities recognize prudential measures are not substitutes for interest rate policy and will rely more on interest rates for stabilization while continuing implementation of FSAP recommendations, including upgrading NBR risk-assessment capacity in preparation for Basel II. ### Structural policies - Ambitious structural reform program continued: privatization in the banking sector to continue with sale of CEC (last state-owned bank), final bids expected in May. Price will weigh most heavily in selecting investors. - Authorities acknowledge that further labor market reforms are needed beyond recent amendments to the Labor Code, including elimination of the obligatory nature of collective wage contracts for non-signatory parties. - Rapid progress on judicial reform to strengthen governance and improve business climate. - National Anticorruption Prosecutor Office recently established and will be able to investigate and prosecute members of Parliament. *Source: Excerpt from IMF staff report PDF content provided in the supplied source content.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06168.pdf_