IMF Executive Board Concludes 2023 Article IV Consultation with Romania
IMF News, December 8, 2023
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- Published: December 8, 2023
Recent economic developments
- Romania has weathered shocks from the pandemic and Russia’s war in Ukraine relatively well.
- Growth:
- 2022: 4.7 percent (surprised on the upside).
- First half of 2023: slowed to around 1.9 percent y/y due to weakened consumption and subdued external demand.
- Inflation:
- Peak: 16.8 percent y/y in November 2022.
- September 2023: 8.8 percent y/y.
- Drivers of decline: base effects, price caps on energy, receding energy and food prices, easing supply bottlenecks, and monetary tightening.
- Investment: public and private investment has accelerated further.
- Financial sector: remains robust, though corporate FX borrowing has increased.
- Fiscal position:
- Structural spending has increased since 2019 without offsetting revenue increases.
- Fiscal consolidation stalled in 2023.
- Current account and reserves:
- Current account deficit remains large but is declining and largely driven by direct investment flows and rising inflows of EU funds.
- International reserves have increased significantly.
Outlook and projections
- Growth projections:
- 2023: projected at 2¼ percent.
- 2024: projected around 2¾ percent (modest recovery as stronger consumption—driven by rising real wages—and external demand are partially countered by the necessary fiscal consolidation).
- Medium term: expected to return to potential around 3¾ percent as consumption and exports recover and investment (underpinned by RRF funds) remains strong.
- Inflation:
- Projected to return inside the NBR’s target band in early 2025, helped by weaker economic growth and falling food and energy prices (which comprise almost half of the consumption basket).
- Fiscal projections:
- Staff projects the deficit in 2023 at 6 percent of GDP.
- 2024: without further fiscal measures, deficit forecast to fall to slightly above 5 percent of GDP.
- Current account medium-term projection:
- Projected to narrow moderately to around 6 percent of GDP owing to fiscal adjustment and—near the end of the projection horizon—declining EU capital grants.
Executive Board assessment — key findings
- Overall performance:
- Romania’s economy has performed relatively well in difficult times; growth remains fairly robust and higher than most peers.
- Inflation, after peaking at lower levels than in CESEE peers, remains too high but is receding gradually.
- Convergence to Western European income levels is continuing.
- External position:
- Romania’s external position in 2022 was substantially weaker than the level implied by fundamentals and desirable policies (assessment subject to considerable uncertainty).
- Risks:
- Escalation of the war in Ukraine, further weakening of activity across Europe, or an abrupt global slowdown could undermine growth and capital flows.
- Prolonged strong wage growth could delay the projected fall in core inflation.
- The electoral calendar could make fiscal consolidation and structural reforms in 2024 difficult to achieve.
- Fiscal vulnerability:
- A structural budget deficit well in excess of sustainable levels limits scope to respond to adverse developments.
- Continued efforts to improve expenditure efficiency and tax collection are needed; revenues must be increased given spending pressures to address relative poverty and raise productivity.
Policy recommendations and priorities
- Fiscal policy and tax reform:
- The recently adopted fiscal package provides welcome improvements in tax policy and should help reduce the fiscal deficit somewhat in 2024, but more is needed.
- The reduction of some tax exemptions is a step forward; some measures—particularly the new turnover taxes—are not in line with good practice and should be reconsidered.
- Further tax reforms to raise at least 2 percent of GDP in additional revenue beyond the gains from the recent tax package are needed to place the fiscal deficit on a sustainable medium-term trajectory while ensuring all taxpayers pay their fair share.
- Streamlining VAT and personal income taxes (including closing loopholes and removing tax privileges) should be key elements; once achieved, consideration should be given to re-introduce progressive income taxation.
- Tax and expenditure policies should become more predictable; announcing further tax reforms well in advance will help companies and households adjust.
- Spending on pensions and public sector wages should be set on a sustainable formula-based trajectory, as envisaged in the NRRP.
- The new draft pension law would help reduce spending over the longer run but generate upfront fiscal costs; a gradual phase-in and prudent implementation are needed to avoid jeopardizing deficit reduction.
- Monetary policy:
- Monetary policy should not be relaxed until core inflation is on a firm downward path as needed for returning headline inflation within the tolerance band by early 2025.
- The monetary authorities should be ready to tighten policy if upside risks to core inflation materialize.
- Exchange rate policy:
- The episode of higher exchange rate volatility presents an opportunity to gradually increase two-way exchange rate flexibility over the medium term to reduce destabilizing capital flow risks, raise monetary policy effectiveness, and enhance resilience to shocks.
- Any move should be gradual to preserve confidence gains; enhanced data on inflation expectations would support calibration.
- Financial sector and AML/CFT:
- Emerging financial risks (including increased corporate FX borrowing) warrant close scrutiny.
- The turnover tax on banks could, if maintained for an extended period, weaken banks’ financial buffers and already-low financial intermediation.
- Improvements to the AML/CFT system should be swiftly implemented; authorities should compile an overarching AML/CFT strategy.
- Structural policies to boost growth and convergence:
- Make the most of available EU support to finance investment and support reform implementation.
- Governance reforms to enhance administrative capacity and transparency, fight corruption, and make SOEs more efficient are critical to reinforce investment attractiveness and counteract continued (though declining) net outmigration.
- Raise labor force participation to mitigate effects of a falling population, with focus on increasing opportunities for women in the formal labor force and improving education outcomes.
- Green transition:
- Reducing GHG emissions in line with EU and updated NECP targets is challenging, especially in transport and housing.
- The transition requires large, coordinated investments and complementary policies to mitigate social impacts: disincentivize carbon emissions (including through taxation) while shielding low-income households.
- Scheduled coal mine closures require special efforts for compensation and new opportunities for affected households.
- Romania’s large potential for renewable energy offers opportunities to benefit from decarbonization and become more competitive in green value chains.
Selected economic indicators and key statistics (as reported)
- Population (million): 19.0
- Per capita GDP ($): 15,791
- Quota (m SDRs/% of total): 1,811 (0.4%)
- Literacy rate (%): 98.9
- Poverty rate (%) 1/: 21.2
- Key export markets: EU (Germany, France, Italy)
- Main products and exports: Machinery and transport equipment, manufactured goods
- Annual indicators (2021 / 2022 / 2023 / 2024 projections)
- Real GDP (% change): 5.7 / 4.6 / 2.2 / 2.7
- Unemployment (% labor force): 5.6
- Consumer prices (avg): 5.0 / 13.8 / 10.5 / 5.8
- Consumer prices (eop): 8.2 / 16.4 / 7.4 / 4.4
- General government revenue (% GDP): 30.4 / 31.0 / 31.9
- General government expenditure (% GDP): 37.1 / 36.8 / 37.9 / 37.0
- Net lending/borrowing (% GDP): -6.7 / -5.8 / -6.0 / -5.1
- Structural balance (% GDP): -7.4 / -5.7 / -5.6 / -4.8
- Structural primary balance (% GDP): -5.9 / -3.7 / -3.2 / -2.6
- Gross debt (% GDP): 51.7 / 50.5 / 51.6 / 52.2
- Broad money (% change): 15.8 / 6.9 / 13.6 / 10.0
- Credit to the private sector (% change): 14.8 / 12.1 / 6.3
- Policy rate (eop, %): 1.75 / 6.75 / …
- Current account (% GDP): -7.2 / -9.3 / -6.9
- Direct investment, net (% GDP): -3.4 / -3.0 / -3.3
- International reserves (months of prospective imports): 3.9 / 4.3 / 4.7
- External debt (% GDP): 56.5 / 50.6 / 51.2
- REER (% change): 1.0 / 3.7
Source: IMF Executive Board Concludes 2023 Article IV Consultation with Romania (Press Release No. 23/427).
