Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with Romania

May 30, 2007

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

Public Information Notice (PIN) No. 07/61
May 30, 2007

On May 23, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Romania.1


Romania stands at a historic juncture. Accession to the European Union on January 1, 2007 represents a substantial achievement and reflects a determined stabilization effort on the part of the authorities. Output growth has been very strong at 7.7 percent for 2006, and headline inflation has fallen, reaching 3.7 percent (year-to-year) in March 2007 compared to 8.4 percent for the same period last year. For most of 2006, the authorities maintained a policy of fiscal consolidation, owing to strong revenue collections and underutilization of the capital budget. Similarly, the National Bank of Romania focused on strengthening the credibility of Romania's inflation-targeting framework, tightening monetary conditions and successfully meeting its end-2006 inflation goal.

Nonetheless, despite healthy export growth, the current account deficit widened to 10.3 percent of GDP in 2006, as growing excess demand, rising wages, and strong credit growth helped prompt a surge in imports. Moreover, fiscal policy was loosened significantly in December, driving the budget balance from a surplus in November to an end-year deficit of 1.7 percent. The fiscal deficit target for 2007 is wider still at 2.8 percent and substantial government wage increases have already been approved (up to 20 percent) along with an 18-percent minimum-wage hike for 2007. In addition, appreciation pressures in early 2007 set the background for a loosening of the key monetary policy instrument. The policy interest rate was cut from 8.75 percent to 8.00 percent in February and by a further 50 basis points to 7.5 percent in March.

Executive Board Assessment

Executive Directors commended Romania's accomplishments—including strong output and export growth, substantial disinflation, low external debt, and a comfortable level of international reserves—which paved the way for Romania's recent accession into the EU. Directors cautioned, however, that the economic outlook is clouded by a widening current account imbalance and the risk of a resurgence of inflationary pressures, as a result of strong domestic demand that is being fuelled by rapid credit growth and procyclical fiscal and incomes policies.

Directors emphasized the need for policies that reduce vulnerabilities, support sustainable growth, and maximize the gains from EU membership. Key medium-term challenges will be to raise per capita income, which remains well below the EU average, and to lay the groundwork for eventual euro adoption. Against this background and to guard against sudden shifts in market sentiment in the current uncertain political environment, Directors called for consistent and prudent fiscal, incomes, and monetary policies, and vigorous implementation of structural reforms.

Directors expressed concern about the recent procyclical fiscal loosening and the possibility that Romania may fail to meet the Maastricht criteria in its first year of EU membership. They urged a tighter fiscal stance in 2007 to contain domestic demand, accompanied by the establishment of prudent medium-term fiscal goals. Given Romania's pressing expenditure needs and low revenue ratio, Directors stressed the need to permanently boost revenue, and welcomed plans to strengthen tax administration and broaden the tax base.

Directors urged the authorities to strengthen public financial management, restrain expenditure growth, and enhance the quality and composition of public spending. In particular, multiple budget revisions and back-loaded expenditure should be avoided, and all approved expenditure should be reflected in the budget. Directors also encouraged the development of a credible medium-term fiscal framework to enhance the transparency and effectiveness of budget planning and execution, and to improve the efficiency of absorbing EU funds.

Directors considered that the envisaged wage policy for this year—including a sharp increase in the minimum wage and three rounds of increases in government wages—is incompatible with the inflation objective and could spill over to the private sector. They urged the authorities to pursue wage increases only once a year and to ensure that these are moderate, transparent, and fully incorporated in the budget.

Directors commended the central bank's commitment to price stability and the success in reducing inflation. At the same time, given the need to firmly anchor inflationary expectations and the credibility of the inflation targeting framework, Directors considered the recent interest rate cuts to be premature. They urged the authorities to increase interest rates as needed to attain the inflation targets. Although this may put further upward pressure on the currency, Directors noted that the exchange rate remains competitive and that the appreciation will help to contain inflation. Directors also considered it important to avoid any deviation between the policy and effective interest rates, and to reduce reserve requirements cautiously.

Directors were encouraged that financial soundness indicators and stress tests point to a relatively healthy and resilient financial system. Nevertheless, they cautioned that rapid growth of credit to the private sector, particularly foreign currency credit, can magnify medium-term vulnerabilities. Directors therefore emphasized the importance of effective domestic and cross-border supervision and regulation, and commended the central bank's continued progress in developing its capacity for assessing overall stability. They welcomed the authorities' interest in a Financial Sector Assessment Program update this year.

Directors emphasized the importance of ambitious structural reforms to support convergence to EU living standards. They encouraged the authorities to accelerate privatization in the energy sector and to announce a schedule for adjusting domestic producer gas prices in line with opportunity costs. Romania's low labor-market participation and employment rates suggest the need for a strategy encompassing an improved education system and enhanced labor-market flexibility. Directors encouraged the authorities to strengthen their efforts to introduce a second pension pillar and to improve the legal framework with a view to reducing corruption and enhancing the business environment.

Romania: Selected Economic and Social Indicators

  2002 2003 2004 2005 2006 2007
  Prel. Estimate Staff Projections
Baseline 1/  Adj.

Real economy (change in percent) 2/
Real GDP 5.1 5.2 8.5 4.1 7.7   7.0 6.5
Final domestic demand 5.5 8.3 10.4 10.1 12.5   10.8 9.1
CPI (end of period) 17.8 14.1 9.3 8.6 4.9   5.5 4.5
CPI (period average) 22.5 15.3 11.9 9.0 6.6   4.8 4.4
Unemployment rate (end of period; percent) 8.4 7.2 6.2 5.8 5.4   5.1 5.1
Gross national saving (percent of GDP) 18.3 16.0 15.4 14.0 14.0   13.4 14.9
Gross domestic investment (percent of GDP) 21.7 21.8 23.8 22.7 24.2   25.1 25.1
Public finance (general government, percent of GDP) 3/
Revenue 29.6 28.7 30.0 30.2 31.2   33.5 34.1
Expenditure 32.3 30.9 31.1 31.0 32.9   36.3 34.9
Overall balance -2.6 -2.2 -1.0 -0.8 -1.7   -2.8 -0.9
Primary balance 0.4 -0.2 0.2 0.3 -0.9   -1.9 0.0
Total public debt 4/ 26.0 23.6 23.2 19.9 18.5   18.7 17.3
Money and credit (end of year, percent change)
Nominal domestic credit 38.1 64.4 40.5 37.2 66.1   58.4 39.5
Real domestic credit 5/ 38.2 23.3 40.1 33.8 29.4   42.4 36.0
Broad money 38.2 23.3 40.1 33.8 29.4   36.0 30.0
Interest rates (percent) 6/
NBR interest rate (end of period) 21.5 23.4 18.8 7.2 8.8   - -
Treasury bill rate (end of period) 17.4 18.4 11.5 5.5 5.5   - -
Balance of payments (percent of GDP)
Trade balance -5.7 -7.5 -8.8 -9.8 -12.1   -13.5 -12.5
Current account balance -3.3 -5.8 -8.4 -8.7 -10.3   -11.7 -10.2
Foreign direct investment 3.1 3.7 8.4 6.6 9.3   5.9 6.4
External debt 30.8 29.9 30.6 31.1 28.6   26.4 26.1
Official reserves (end-year, US$ million) 7,137 9,208 15,999 21,648 28,155   30,030 32,288
Reserve cover (months of prospective imports, in € terms)) 3.8 3.3 4.1 5.1 4.8   4.5 5.0
Exchange rate
Lei per euro (end of period) 3.51 4.17 3.96 3.66 3.41   - -
Lei per US$ (end of period) 3.35 3.30 2.91 3.08 2.58   - -
NEER appreciation (+) (percent) -14.4 -11.1 -5.1 10.5 2.7   - -
REER appreciation (+) (CPI-based, in percent, period average) 0.8 -3.2 2.6 18.0 7.6   - -
REER appreciation (+) (ULC-based, in percent, period average) -6.5 -5.5 5.1 24.9 3.8 7/ -  
Main export products are textiles and light machinery.
Social indicators (reference year):
Per capita GDP (2005): $4,445; income distribution (GINI coefficient, 2000): 30.3;
Poverty rate (2005): 13 percent; primary education completion rate (2004): 94 percent; gender pay gap (2003): 18 percent;
Life expectancy at birth (2004): 71.3; infant mortality per 1000 live births (2004): 16.8.

Sources: Romanian authorities; and Fund staff estimates and projections.
1/ Assuming an unchanged policy mix, including a 2.8 percent of GDP fiscal deficit in 2007.
2/ National accounts data are based on ESA95 guidelines.
3/ Beginning 2004, fiscal data are based on a new classification and thus they are not comparable to series before 2004.
4/ Including domestic public debt and external public debt (public and publicly guaranteed).
5/ Credit to the nongovernment sector; weighted average of real lei credit growth and U.S. dollar-measured foreign currency credit growth.
6/ NBR effective policy rate (combined sterilization operations and use of deposit facility), compounded. Treasury bill rate for 2007 is quoted from the most recent auction, on January 15, 2007.
7/ Average for period January-October.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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