Romania -- 2008 Article IV Consultation, Concluding Statement of the Mission
IMF News, May 2, 2008
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- Published: May 2, 2008
Concluding findings and context
- Mission location and date: Bucharest, April 21, 2008; publication date May 2, 2008.
- Romania has experienced rapid real convergence but growing macroeconomic imbalances.
- Key observations:
- In 2007, real GDP grew by a robust 6 percent, despite a drought-induced slump in agriculture.
- Per capita GDP, based on purchasing power parities, is still only about 37 percent of the euro area's level, but Romania has narrowed its income gap by about 10 percentage points since 2003.
- Global financial market tensions have increased concerns because Romania depends on continued large external financing.
Macroeconomic developments
- External position and competitiveness:
- The current account deficit reached 14 percent of GDP in 2007.
- Massive capital inflows have fueled a domestic spending boom (investment and consumption exceeding incomes).
- Despite exchange rate volatility (appreciation until mid-2007, sharp depreciation with global tensions), exporters continued to gain market share; external price and cost competitiveness at current exchange rate levels remains intact according to the mission's analysis.
- Inflation and capacity constraints:
- High headline CPI inflation is a concern; driven largely by supply-side shocks to food and energy (likely one-off) and rising domestic demand hitting capacity bottlenecks.
- Tight labor market and underdeveloped public infrastructure constrain supply.
- Private-sector wage growth is outpacing productivity growth; public-sector wage and employment policies add to wage-push inflation.
- Recent surge in PPI inflation and survey data indicate inflation expectations may be creeping upward.
- Financial sector vulnerabilities:
- Real private credit expanded by some 50 percent in 2007, increasingly funded by foreign borrowing.
- Strong growth in domestic foreign-currency credit, including a surge in Swiss-franc denominated credits from a low base, and direct foreign borrowing have increased currency mismatches in corporate and household balance sheets.
- Banking-sector capital buffers have declined and non-performing loans have increased, though financial soundness indicators for the banking sector as a whole still look relatively solid.
Policy developments
- Fiscal policy:
- 2007 cash fiscal deficit increased to 2¼ percent of GDP, up from ½ percent of GDP in 2006.
- Estimated 2007 structural deficit surged to 3½ percent of GDP (adjusted for automatic effects of the booming economy).
- Fiscal stance added an estimated net fiscal stimulus of 2¼ percent of GDP to an already overheating economy.
- Budget process was highly short-term oriented: the originally approved 2007 budget was rectified four times; limited success in tapping EU grants in the first accession year; mid-2007 fast-tracked pension hike proposal for 2008-09 with unclear financing.
- Monetary policy:
- NBR eased policy rates aggressively in the first half of 2007 in response to appreciation and declining inflation, but reversed course starting July 2007 as food and energy prices surged and the exchange rate depreciated.
- The NBR raised its policy rate in several steps to 9.5 percent.
- Measures to contain banking vulnerabilities: additional provisions on foreign-currency denominated loans to unhedged borrowers took effect in March 2008; new regulation required banks to strengthen liquidity management.
- Structural reforms:
- Pace of structural reforms slowed, in part reflecting political gridlock.
- Romania trails best-performing new EU member peers on most structural reform indicators, with particular lags in business licensing, ease of employing workers, registering property, public infrastructure, and control of corruption.
Macroeconomic outlook and scenarios
- Increased uncertainty due to global financial market tensions and potential re-pricing of financial risk.
- Revised baseline projections (mission):
- GDP growth: 5½ percent in 2008 and 4¾ percent in 2009.
- Headline inflation: 6½ percent (end-year) in 2008; projected to decline back into the NBR's inflation target corridor in 2009 assuming tight monetary stance and subsiding supply shocks.
- Two alternative scenarios bracket the baseline:
- Continued boom:
- Large capital inflows continue, trading partner growth surprises on the upside, and high business and consumer confidence persist.
- Growth could stay high, the current account deficit would widen further, and controlling underlying inflation pressures could become even more challenging.
- Sharp slowdown:
- Confidence could slump abruptly, trading partner growth and capital inflows could contract sharply.
- Inflation and the current account deficit would correct more quickly, but risk of a sharp slowdown turning into an economic bust would be significant.
Policy recommendations — overarching
- Policies must be more coordinated and forward-looking under any scenario.
- Fiscal and incomes policies need tightening relative to plans in the baseline, and significantly more so under the continued-boom scenario.
- Monetary policy must keep inflation expectations firmly anchored in all scenarios.
- Financial sector policies should monitor and preempt financial stability risks under baseline or boom; a sharp-slowdown could require reactive interventions.
Fiscal policy — recommended framework and specific advice
- Desirable features of a stability- and growth-oriented fiscal framework:
- Medium-term fiscal deficit target of about 1 percent of GDP when the economy is at external and internal balance.
- Avoid procyclicality to help stabilize the economy in coordination with monetary policy.
- Mobilize and spend scarce budget resources efficiently on programs that strengthen the supply side while attending to social protection needs.
- Assessment of the 2008 budget:
- Originally approved 2008 budget targeted a deficit of 2¾ percent of GDP; recent rectification reduced the target to 2¼ percent of GDP.
- Mission view: a lower deficit target of about 1¾ percent of GDP would have been more appropriate.
- Mission views revenue projections as overoptimistic; spending plans will likely need curtailment.
- Significant risks to the 2008 fiscal deficit (mission highlights three):
- Approved cut in the VAT rate on food items from 19 to 5 percent; full-year fiscal cost could amount to up to ½ percent of GDP, depending on implementation details.
- Suggestions to bring forward the already approved pension increase from January 2009 to an earlier date; full-year fiscal cost of the pension increase would amount to about 1½ percent of GDP.
- Potential significant overruns in the public sector wage bill, which the 2008 budget seeks to broadly stabilize (as a percent of GDP) at the 2007 level.
- Strengthening fiscal policy culture — three-pronged approach to be implemented in parallel:
- Upgrade fiscal expertise and capacity at the executive and legislative levels (strengthen budget formulation, transparency, analysis, audit, accounting, and shift to performance-based budgeting).
- Modify rules and procedures to reduce short-term policy orientation (reduce scope for multiple budget rectifications; reconsider modalities of emergency ordinances; require that all revenue and spending items in the approved budget be supported by already approved legislation).
- Set up an independent fiscal agency (short-term: independent expert panel for macroeconomic and revenue forecasts; over time consider expanding role to assess specific budget proposals).
Monetary policy — recommendations
- Maintain the inflation-targeting (IT) framework; mission sees little merit in raising the inflation target or widening the band.
- Continue upgrading IT implementation capacity; consider an independent expert review of the framework following best-practice IT central banks.
- Monetary stance should remain clearly focused on lowering inflation in line with the announced target path.
- Absent a sharp-slowdown scenario, additional policy tightening may be needed to keep inflation expectations anchored and bring inflation back into the end-2009 target range.
- NBR should weigh the impact of further policy rate increases on financial vulnerabilities and avoid signaling unconditional threshold aversion for the policy rate or the leu/euro exchange rate.
Financial sector policies — recommendations
- Intensify financial sector surveillance and refine stress testing methodologies (including stronger feedback effects between the real economy and banking soundness indicators).
- Remedy statistical gaps (e.g., reliable real estate price statistics); planned update of the Financial Sector Assessment Program later in the year will enable a comprehensive review.
- Consider additional preemptive measures to reduce financial stability risks:
- Higher capital requirements for riskier exposures, including real estate exposures.
- Complement new liquidity regulation with on-site inspections of selected banks.
- Consider broadening the range of eligible collateral for the NBR's overdraft facility.
- Continue encouraging monitoring and containment of operational risks, especially given banks' aggressive market-share competition and promotion of exotic credit products.
- Coordinate regulatory and prudential actions with pertinent foreign regulators, building on the memorandum of understanding on cross-border financial crisis preparedness signed by all EU countries.
Romania -- 2008 Article IV Consultation, Concluding Statement of the Mission (May 2, 2008).