Press Release No. 21/147

Romania 2021 Article IV Staff Concluding Statement

May 28, 2021

• While the COVID-19 pandemic represented a severe shock to the Romanian people, the economy experienced a relatively shallow recession in 2020 compared to other European Union (EU) countries, aided by supportive macroeconomic policies. A strong economic recovery is underway in 2021.
• The government’s main tasks are to ensure speedy vaccination, continue to provide pandemic-related support, and move ahead with a medium-term budget correction of pre-pandemic excesses in order to rebuild room for policy maneuver. Monetary and financial policies need to remain accommodative to entrench the economic recovery.
• Economic performance in the years ahead should be bolstered by these efforts and by re-starting a range of structural and governance reforms and taking full advantage of the opportunities provided by large Next Generation EU funds.

The Romanian economy fared relatively well during the COVID-19 crisis…

1. The GDP contraction in 2020 induced by the pandemic was significantly milder than the EU average. This reflected in part a more limited initial virus outbreak and short-lived surges in subsequent virus waves without a second national lockdown. Effective public health measures and a fast start of vaccinations have also helped. Importantly, household and business livelihoods benefitted from coordinated fiscal and monetary policy easing that helped curb the economic downturn and the rise in unemployment. This was a welcome contrast to the policy tightening applied in previous economic crises in Romania. Bolstered by global monetary easing and EU support measures, external financing has been favorable.

· The authorities provided the necessary fiscal support similar to other EU countries: first, increased health care expenditures; second, income support measures in the form of temporary wage subsidies, and targeted hiring incentives; and third, business support with grants and liquidity extended through tax deferrals and credit guarantees predominantly targeting SMEs. These support measures have been extended into 2021.

· Timely and decisive actions by the National Bank of Romania (NBR) helped ensure financial market functioning and sustain the flow of credit during the pandemic. These included interest rate cuts, an asset purchase program for government bonds, as well as provision of liquidity, regulatory easing and bank loan repayment moratoria.

A strong economic recovery is projected in 2021. EU funds are critical to the outlook in the years beyond…

2. A strong, 7 percent real GDP rebound is projected for 2021. Romania’s economic pickup appears to have been the fastest among the EU countries since Q4 2020. A better agricultural harvest is expected to support output later this year. The main downside risk to the outlook stems from unexpected adverse shifts in the evolution of the pandemic, including possibly due to new virus strains, shorter vaccine effectiveness, or unwillingness to vaccinate.

3. Over the next five years, absorption of large EU funds will be pivotal to Romania’s economic performance. The available resources present a unique opportunity to fast-track income convergence with the EU and transition to a more digital and greener economy.

Fiscal support needs to continue…

4. Despite the strong recent economic recovery, continued fiscal support remains essential to combat the uneven economic fallout of the pandemic. The support would help ensure that no group is left behind.

· Speedy vaccine rollout is the most important policy to combat the pandemic, with economic returns that greatly exceed its fiscal costs. Fiscal policy can contribute with continued generous funding.

· Temporary income and business support measures, such as kurzarbeit allowances and grants to SMEs, need to be maintained, while shifting focus towards the most affected sectors, including HoReCa and transport, and disadvantaged groups, for example, women and the less educated.

…while the groundwork is laid to rebuild space for fiscal maneuver

5. The 2021 budget ensures continued support of the recovery, while also laying a foundation for rebuilding fiscal space, so that government can again protect people’s incomes next time an economic calamity hits. Fiscal expenditures have shifted towards investment, including based on EU funding, which should stimulate Romania’s medium-term economic capacity to create jobs and generate income. This shift also reflects a welcome moderation in the growth of public sector wages and pension benefits. Going forward it will also be important to carve out adequate resources to protect the most vulnerable households. The stronger than expected economic recovery in recent months has helped the fiscal outlook. The resulting revenue windfall should be saved. On that basis, the fiscal deficit in 2021 is now estimated at 6.8 percent of GDP, below the government’s budgeted deficit target of 7.2 percent of GDP.

6. As the recovery is becoming entrenched, policy efforts should focus on fiscal-structural reforms to help rebuild room for fiscal policy maneuver over the medium term and comply with EU norms.

· Strengthening revenue administration is critical to raise tax collection towards average EU levels. Reforms are urgently needed to modernize IT infrastructure, strengthen compliance risk management to combat tax avoidance and to improve ANAF governance and staffing. The potential gains from strengthened revenue administration are sizeable, but their realization will be gradual and require a sustained reform effort. We welcome the strong commitment from the government towards these reforms.

· Broadening the tax base and closing loopholes would help achieve a more equitable distribution of the tax burden, so that everyone contributes their fair share. Eliminating disparities in income taxation would improve transparency and productivity of the tax system, further encouraging compliance.

· Improving and speeding up public investment management processes will be essential to increase the quantity and quality of public infrastructure, including for transportation, water supply and access to digital services. Progress in this area is paramount to make the best possible use of the available EU recovery and structural funds. Improvements are needed in all aspects of public investment management, from planning and project prioritization to implementation.

Monetary and financial policies to stay accommodative while preparing for recovery…

7. The NBR decisively eased monetary and financial policies in response to the pandemic. Inflation is expected to rise into the end of this year due mainly to electricity and fuel-related price adjustments, but these are projected to fade away in 2022, allowing inflation to return within the target band. Continued accommodative monetary policy to help secure the recovery is appropriate given well-anchored inflation expectations, the negative output gap and muted wage growth projections, and pandemic-related uncertainties. As fiscal consolidation gets underway, extending monetary accommodation beyond this year can be appropriate, as long as consistent with the inflation target. Amidst the strong economic growth, the current account deficit, however, is projected to widen further this year to around 5½ percent of GDP. As the crisis recedes, gradually increasing exchange rate flexibility would help to absorb external shocks and, together with fiscal consolidation, could also help address the current account deficit.

8. The Romanian banking system entered the COVID-19 pandemic from a position of strength, with strong capital, liquidity, and profitability against a backdrop of conservative supervision. The stronger economic recovery has also benefitted asset quality thus far, with non-performing loans remaining low into 2021. Building on pre-pandemic levels of loan loss provisioning in the banking system, above the EU average, banks preemptively raised provisions further in 2020. NBR recommendations, mirroring EU-wide guidance, to limit dividend payouts and share buybacks have also helped to raise capital retention in the system. Loan classification standards have appropriately been restored in 2021, and the debt service moratoria expired in March with the bulk of loans previously under moratoria having been repaid. These actions will help enhance visibility on asset quality going forward. Nonetheless, in case loan portfolios deteriorate materially going forward, the use of capital can be accommodated while allowing a longer period to rebuild. Further, preparations need to be in place for efficiently handling a potential increase in debt restructuring and business insolvencies.

Improving economic governance would boost economic growth

9. Romania’s efforts to fight corruption during the EU accession period have been recognized internationally. However, both the fight against corruption and efforts to improve government effectiveness need to be re-energized. There cannot be convergence of living standards to those in richer EU economies without convergence in economic governance standards. Our estimates show that a sustained governance reform effort could meaningfully accelerate the speed of income convergence. Improved governance would also help to address other major social challenges, such as inequality, emigration, and informality.

10. Governance improvements should be an integral part of revenue administration reforms, including to limit corruption vulnerabilities. Effective governance is also central to improving public investment management.

11. Strengthening the governance of SOEs will be crucial for absorbing EU funds, bridging public infrastructure gaps with EU peers and meeting climate targets. Better corporate governance of SOEs would be an important first step. Reversing the worsening financial performance of SOEs is another priority, requiring enhanced monitoring and necessary reforms of SOEs with a heavy presence in the energy and transport sectors.

An IMF staff team virtually visited Bucharest during May 10-28 for the 2021 Article IV consultation discussions. The team is grateful to the authorities and other counterparts for the excellent facilitation and constructive dialogue.