Romania: Staff Concluding Statement of the 2022 Article IV Mission
IMF News, June 10, 2022
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- Published: June 10, 2022
Mission overview and context
- IMF mission led by Jan Kees Martijn visited Bucharest from May 30 to June 10 to conduct discussions on the 2022 Article IV Consultation with Romania; mission statement dated June 10, 2022.
- Romania recovered well from the COVID pandemic: GDP reached pre-crisis levels in the first half of 2021 and rebounded very strongly in Q1 2022.
- New headwinds from the war in Ukraine: surging commodity prices, input shortages, weakening consumer and external demand, higher sovereign risk premia; more than one million Ukrainian refugees crossed the border (most moved on to third countries).
- Pre-existing vulnerabilities: elevated current account and fiscal deficits; a significant part of the current account deficit financed by EU grants and direct investment flows; reserves broadly adequate but rising interest costs pose risks.
- Fiscal pressures from the pandemic and war are increasing debt and necessitate medium-term consolidation.
Near-term outlook and risks
- Baseline projection:
- Growth is projected to moderate to around 3½ – 4½ percent in 2022 and 2023.
- Annual inflation is expected to average 12½ percent in 2022 and persist around 10 percent in 2023.
- Uncertainty is high. Key risk channels highlighted:
- Broad Russian gas shut-off would raise energy prices further and reduce activity in European trade partners.
- High inflation could reduce demand further and trigger a wage-price spiral.
- External and domestic financing conditions may tighten more than anticipated.
- Domestically, stalling reforms could weaken confidence and risk a credit rating downgrade.
- Upside: rapid implementation of reforms under Romania’s National Recovery and Resilience Plan (NRRP) could lift growth above the baseline.
- Direct risk mitigants noted: Romania is a substantial grain producer, largely self-sufficient in energy with only limited imports from Russia, and other direct trade and financial links with Russia and Ukraine are negligible.
Managing the energy price shock
- Policy stance:
- Measures should cushion the impact on the most vulnerable while incentivizing energy conservation.
- Through March 2023, authorities are implementing targeted payments to vulnerable households and a price cap for most users at levels prevailing before the surge in energy prices in fall 2021.
- Budgetary cost expected to be broadly offset by windfall profit taxes on energy producers and higher dividend payouts of state-owned enterprises (SOEs).
- Operational recommendations:
- Ensure compensating suppliers system works well to avoid cash-flow bottlenecks.
- Consider starting to raise the price caps before March 2023 to avoid a sudden price shock and promote energy efficiency.
- Any renewed fiscal support in the event of further shocks should be well-targeted at poor households.
Fiscal policy: rebuilding fiscal space
- Near-term fiscal assessment:
- Authorities intend to reduce the fiscal deficit in 2022 to 5.8 percent of GDP; the mission projects it at 6¾ percent based on current policies.
- With administrative reforms and lapse of temporary support measures, the deficit is forecast to moderate over the medium term, but debt would continue to rise.
- Fiscal sustainability target:
- To reduce the deficit to a sustainable level below 3 percent of GDP and stabilize debt, tax policy measures amounting to at least 2 percent of GDP should be implemented.
- Revenue-side reform recommendations and estimated yields:
- Personal Income Tax (PIT): comprehensive reform to clean up the tax base could yield more than 1¼ percent of GDP; introducing progressivity for the highest incomes could generate additional revenue and mitigate high income inequality.
- Value Added Tax (VAT): raising VAT efficiency to the EU average through base broadening, streamlining, and additional administrative strengthening could yield 1½ percent of GDP.
- Property Tax: broadening the base, market-based valuations, and simplified design could yield about ¼ percent of GDP.
- Taxation of carbon emissions—once the current price spike has receded—could be an additional revenue source while contributing to the green transition; such revenues could be used to reduce income taxes for lower-income earners.
- Expenditure-side recommendations:
- Expenditures on pensions and public sector wages need to become more predictable.
- Implement pension system reforms committed in the NRRP expeditiously.
- Set public sector wages predictably and consider their influence on private wages and competitiveness.
- Strengthen medium-term budgeting.
- Administrative reforms:
- Continue efforts to modernize revenue administration, including digitalization and improved taxpayer services, in line with NRRP commitments.
Monetary and financial sector policies
- Monetary policy assessment:
- Monetary tightening by the National Bank of Romania (NBR) has helped anchor inflation expectations; policy rate increases and tight liquidity management aligned with global and regional trends.
- Pass-through of energy and food prices to core inflation continues to rise.
- Policy guidance:
- Under the baseline scenario, continuing the pace of recent policy rate step increases through the end of 2022 would help prevent entrenchment of inflationary pressures and guide inflation expectations back toward the target band.
- Monetary policy should react nimbly and be communicated clearly.
- If longer-term inflation expectations rise further while growth stays robust, accelerating the pace of tightening relative to the suggested trajectory would be warranted.
- Acting firmly is important to prevent a wage-price spiral; large public sector wage increases could trigger such a dynamic.
- Conversely, faster normalization of prices for supply-constrained goods or stronger reaction of core inflation to recent rate increases may allow smaller future policy rate steps.
- Exchange rate:
- A broadly stable exchange rate against the euro has avoided fueling inflation and underpinned confidence.
- Exchange rate flexibility should be gradually increased over time, together with necessary fiscal consolidation, to help absorb external shocks and address weakened external competitiveness.
- Financial sector stability:
- Romanian banking system maintains strong capital, liquidity, and profitability; NPL ratio has fallen below pre-pandemic levels; loan-loss provisioning remains much higher than the EU average.
- Financial intermediation has improved with strong credit growth over the past two years.
- Credit guarantee schemes should be reduced over time.
- Raising the countercyclical capital buffer was appropriately calibrated.
- Application of the new loan moratorium needs to be limited to affected borrowers.
Structural reforms and the green transition
- NGEU funds:
- Additional funds under the NGEU program are an important opportunity but Romania lags peers in absorbing EU funds.
- Authorities should expeditiously implement IMF recommendations for public investment management: strengthen medium-term planning, develop a centralized coordination mechanism, and create a pipeline of appraised investment projects across sectors.
- Climate and energy investments:
- Better public investment management would help implement climate policies in the NRRP.
- Romania consumes less energy per capita than most EU countries, but investments required to meet NRRP climate targets are large and need prompt execution.
- Priority investments to strengthen energy security include the new gas interconnector with Bulgaria and development of new gas fields in the Black Sea.
- Taxation of carbon emissions (after the price spike recedes) could support the green transition and raise revenue.
- Broader structural priorities:
- Expand digitalization.
- Strengthen the anti-corruption framework.
- Improve health and education systems.
- Reform SOEs.
- Address large income gaps between regions by strengthening regional and local capacity and infrastructure.
Key policy priorities (summary bullets)
- Ensure energy compensation is temporary, targeted, and promotes conservation; start raising price caps before March 2023 where feasible.
- Implement tax policy measures amounting to at least 2 percent of GDP to reach deficit below 3 percent of GDP; specific revenue measures include PIT reform (>1¼ percent of GDP), VAT efficiency gains (1½ percent of GDP), and property tax reforms (about ¼ percent of GDP).
- Continue monetary tightening as needed to return inflation and inflation expectations to the NBR’s target band; communicate strategy clearly and act decisively to prevent a wage-price spiral.
- Gradually increase exchange rate flexibility alongside fiscal consolidation.
- Preserve banking sector soundness while maintaining credit flow; reduce credit guarantees over time and limit loan moratoriums to affected borrowers.
- Improve public investment management and absorb NGEU funds efficiently; prioritize energy security and NRRP climate investments.
- Advance structural reforms to boost productivity: digitalization, anti-corruption, health and education, SOE reform, and regional capacity building.
International Monetary Fund — Staff Concluding Statement of the 2022 Article IV Mission to Romania (June 10, 2022).