Romania: Staff Concluding Statement of the 2017 Article IV Mission
IMF News, March 17, 2017
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- Published: March 17, 2017
Context and outlook
- Real growth reached 4.8 percent in 2016.
- Growth is projected at 4.2 percent in 2017.
- Low imported inflation and indirect tax cuts have kept inflation subdued despite historic low unemployment.
- Private consumption was boosted by an expansionary and pro-cyclical fiscal policy and wage increases.
- Without a strong push to boost investment, accelerate structural reforms, and strengthen institutions, growth is projected to slow over the medium term and reduce the pace of convergence towards the EU’s income level.
- Risks to the medium-term outlook are tilted to the downside: loss of market confidence if fiscal prudence is perceived abandoned, political tensions, tightening labor market and wage growth in excess of productivity, protracted slowdown in the euro area, and rising U.S. interest rates.
- Upside: prudent economic policies and visible steps to accelerate structural reforms and improve governance would signal Romania as a good place for doing business.
Fiscal policy — main findings and recommendations
- Successive tax cuts have structurally shrunk the revenue envelope while the share of wages and pensions has grown at the cost of investment.
- The current expansionary stance is not warranted by the cyclical position and puts at risk Romania’s favorable macroeconomic indicators relative to peers.
- Recommendation: protect the revenue envelope, moderate wage and pension growth, and aim for a medium-term deficit of 1.5 percent of GDP to rebuild buffers.
- Operational proposal: reduce the 2017 deficit to around 2.3 percent of GDP (a broadly neutral stance) and to 2 percent in 2018.
- The mission projects a deficit of 3.7 percent of GDP in 2017 without additional measures.
- Possible near-term deficit-reduction measures: expenditure reprioritization and postponing a planned pension increase.
- Warning: achieving a 3 percent of GDP deficit target in 2017 without timely action may require withholding the automatic 10 percent spending buffer and delaying capital spending.
General Government Operations and EU Funds (Percent of GDP unless otherwise stated)
- 2016 Prel. / 2017 Proj. / 2018
- Revenue: 29.1 / 29.0 / 29.2
- Tax revenue: 26.0 / 25.8 / (not listed for 2018)
- Revenue from EU funds: 0.5 / 0.6 / 1.1
- Other revenue: 2.5 / 2.4 / 2.3
- Expenditure: 31.5 / 32.7 / 33.1
- Total capital spending: 3.8 / 3.5 / 3.7
- EU projects: 1.2 / 1.0 / 1.9
- Domestic capital spending: 1.7 (2016 only)
- Other expenditure: 27.7 / 29.3 / 29.5
- Cash Balance: -2.4 / -3.7 / -3.9
- Memorandum items:
- Cyclically adjusted balance 1/: -2.5 / -4.1 / -4.2
- Nominal GDP (in billions of lei): 759 / 807 / 866
- Real GDP (percent change): 4.8 / 4.2 / 3.4
- Output gap 2/: 0.3 / 0.9
- Public debt: 39.2 / 40.6 / 41.7
- Sources: Romanian authorities and staff calculations.
- Notes: Figures may not add up due to rounding off. 1/ Expressed as percent of potential GDP. 2/ Percentage deviation of actual from potencial GDP.
Fiscal risks and potential additional measures
- Under current policies, the deficit is projected to deteriorate to 3.9 percent of GDP in 2018 reflecting the full-year effect of the pension increase scheduled to enter into effect in July.
- Other measures in the government’s program (implementation of the unified wage bill, reduction of social security contribution rates, and further tax cuts) could raise the deficit by 5.5 percent of GDP over the next few years.
Fiscal Cost of Potential Additional Measures, 2017-2020 (Percent of GDP)
- Cut in social security contributions — Date of implementation: January 2018 — 2017-2020: (not separately listed)
- Differential reduced PIT — 2017-2020: 1.4
- Reduction in VAT to 18 percent — 2017-2020: 0.4
- Loss of dividends from SOEs — Date of implementation: May 2017 — 2017-2020: (not separately listed)
- Zero-rated VAT for real estate — 2017-2020: 2.1
- Unified wage law 2/ — Date of implementation: July 2017 — 2017-2020: (net effect reported)
- Total effect on the budget — 2017-2020: 5.5
- Note: Staff estimates based on preliminary information as of March 2017. Figures may not add up due to rounding off. 2/ Figures reported in this table represent the net effect on the budget.
Medium-term consolidation — public sector reforms recommended
- Reforming public remuneration:
- Implement a unified wage law that creates a transparent and equitable pay system, avoids labor market distortions, and improves public administration efficiency.
- Implement gradually and in line with available fiscal space.
- Improving revenue collection:
- Accelerate reform of the tax administration (ANAF).
- Priorities: implement a modern compliance risk management approach, strengthen the large taxpayers’ unit, and reform the IT system.
- Enhancing expenditure efficiency and commitment controls:
- Implement recommendations from expenditure reviews and expand reviews to other key sectors.
- Strengthen transparency and the commitment controls system for local investment programs.
- Assess the sustainability of the pension system.
Structural reforms
- Investment and SOEs:
- The quality of infrastructure is amongst the lowest in the EU.
- Strengthen public investment institutions to fully utilize European funds and improve the quality of domestically financed investment.
- Continue efforts to designate managing authorities, comply with ex-ante conditionality, and advance eligibility checks on EU-financed projects.
- Strengthen preparation of large infrastructure projects.
- SOE performance:
- Reenergize privatization and restructuring of SOEs to improve SOE financial performance and reduce arrears.
- A few successful privatizations and IPOs—such as Hidroelectrica which is awaiting appointment of a Supervisory Board—would raise Romania’s international profile as an investment destination.
- Continue appointment of professional board members and managers in accordance with the recently adopted corporate governance law.
- Banks should be excluded from this law because banks are already subject to a specialized corporate governance law.
- Sovereign fund proposal: base the fund on best international practices regarding appointment of management, transparency, auditing, selection of investment projects, and use of state guarantees to minimize fiscal risks.
- Labor market:
- Address mismatches by improving vocational education and training and strengthening the National Employment Agency.
- Caution against continued hikes in the minimum wage as they risk undermining competitiveness and hampering job creation, particularly for low-skilled employees.
- Establish a transparent wage setting mechanism based on clear and objective criteria, especially labor productivity.
- Anti-corruption:
- Continue the drive against corruption; maintain momentum through effective implementation of the national anti-corruption strategy, preventing conflicts of interest in public procurement, and strengthening the management of seized assets.
Monetary policy and financial sector
- Monetary policy:
- The National Bank of Romania should remain vigilant against rising inflationary pressures and consider tightening monetary conditions.
- Under unchanged policies, the mission expects inflation will exceed the upper end of the NBR’s target band by mid-2018.
- Recommend reducing the gap between short-term market rates and the policy rate by narrowing the interest rate corridor and absorbing excess liquidity to prepare for an eventual policy rate hike.
- In the absence of corrective fiscal measures, monetary policy will need to shoulder a bigger burden in managing domestic demand—a suboptimal policy mix.
- Financial sector:
- Mission welcomes the significant reduction in banks’ non-performing loans (NPLs) and encourages close monitoring of banks’ growing exposure to households and the government.
- The NBR has proactively encouraged NPL sales and write-offs.
- Mortgage lending has grown primarily due to the government’s Prima Casa guarantee program.
- Banks have increased holdings of government debt, exposing them to market risk; this growing exposure should be carefully monitored and addressed as needed.
- Recent constitutional court decisions have lessened previous threats to financial stability from potentially damaging laws.
Mission engagement
- The mission visited Bucharest during March 8-17.
- Meetings were held with President Klaus Iohannis, Prime Minister Sorin Grindeanu, Vice-Prime Minister Sevil Shhaideh, Minister of Finance Viorel Ștefan, Governor Mugur Isărescu, Minister of Economy Mihai Tudose, members of Parliament, other public officials, representatives of the private sector, and other stakeholders.
- The mission thanks the authorities and other counterparts for warm hospitality, excellent cooperation, and constructive discussions.
International Monetary Fund staff concluding statement, March 17, 2017.