Romania -- 2007 Article IV Consultation, Concluding Statement of the Mission
IMF News, March 13, 2007
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- Published: March 13, 2007
Recent Developments
- Accession milestone and past performance
- Per capita GDP measured in Euro rose by 130 percent during 2000-06, the fastest among the 27 EU countries.
- Real GDP growth was 7.7 percent in 2006.
- CPI inflation was 4.9 percent y-o-y at end-2006, against the NBR's 5 percent central target.
- Demand, credit, and external balances
- Real domestic credit is estimated to have grown by 66 percent in 2006.
- The current account deficit widened to 10.3 percent of GDP in 2006, compared with 8.7 percent in 2005.
- FDI covered 91 percent of the current account deficit.
- Fiscal developments
- A sharp rise in government spending in December led to an annual deficit of 1.7 percent of GDP compared with a surplus of 1.2 percent of annual GDP during January-November.
- For the year, government expenditure rose by 20 percent in real terms.
- More than 40 percent of the capital budget was spent in December alone.
- The government revised the budget four times, increasing the deficit target from 0.5 percent of GDP to 2.5 percent.
- Wages and employment
- Government employment increased by almost 30,000 (3⅓ percent).
- The government's wage bill increased by 36 percent last year.
- Average statutory wage increases of 9-15 percent (in two rounds) and a minimum wage increase of 6½ percent were implemented.
- Monetary policy and exchange rate
- The NBR unified official policy and effective rates at 8.75 percent in 2006, then reduced the policy rate to 8 percent on February 9.
- Under partial sterilization, the effective rate is about 6-7 percent.
- Structural reform progress
- Privatization: BCR privatization completed; CEC privatization postponed.
- Domestic gas producer price is only 47 percent of the international import price.
- Judicial reform progressed in line with EU commitments, but questions remain on implementation.
Macroeconomic Outlook and Policy Recommendations
- Baseline 2007 projection and risks
- Mission's baseline scenario for 2007 projects continued strong growth, a widening in the current account deficit to 12 percent of GDP, and an inflation outcome outside the target band at end-2007.
- A delay in strengthening macroeconomic policies increases the risk of a change in market sentiment and sudden capital outflows, with consequent exchange rate pressures and banking-system strain.
- Policy guidance
- A clear and coherent set of policies is required to minimize external and financial-system vulnerabilities and to retain positive foreign investor sentiment.
- Tightening of policies (fiscal and incomes) will relieve some burden on monetary policy and help contain the external current account deficit while meeting the NBR's inflation target.
- Convergence requires increased investment (including efficient government spending) and industry restructuring to sustain productivity gains.
Fiscal and Incomes Policies
- Assessment of the approved budget
- The approved budget targets a deficit of 2.8 percent of GDP.
- The mission projects that, on current policies, the underlying budget deficit is about 3.7 percent of GDP.
- Recognition of additional claims related to the Property Fund and possible use of National Development Fund resources would add further to the deficit.
- Recommended fiscal stance
- The mission strongly urges tightening fiscal policy and favors aiming for a general government deficit of below 1 percent of GDP this year, with a smooth path for medium-term fiscal consolidation.
- Given limited scope for revenue measures this year, the majority of adjustment should fall on the expenditure side.
- Potential savings: capital spending (given last December's sharp increase), goods and services, and transfers.
- Public-sector wage policy recommendations
- Reduce envisaged wage increases, impose strict control on bonuses, and closely monitor additional hirings.
- Public sector wages should increase once a year and be incorporated in the budget to anchor inflation expectations in single digits.
- Wages need to better reflect skill needs to avoid undermining civil service reform and absorption of EU funds.
- Revenue and expenditure reform
- Resist calls for further tax reduction under the flat tax (except the social contributions tax) and avoid distortionary exemptions (e.g., a reduced VAT rate or exemption of reinvested profits).
- Increase revenue ratio toward EU levels and prioritize structural expenditure reforms: civil service, health, education, pensions, and infrastructure.
- Institutional improvements
- Improve transparency, monitoring, and establish a credible medium-term fiscal framework that fully incorporates post-accession EU receipts and expenditure.
- Avoid multiple budget revisions and improve public-spending management to ensure a uniform spending pattern over the year.
Monetary and Exchange Rate Policies
- Strategy and timeline
- NBR's guidelines call for entry into ERM II by 2012; the timetable is described as feasible and appropriate.
- The NBR faces the dilemma where higher interest rates to meet inflation goals may increase nominal appreciation pressure.
- Policy recommendations
- The long-run solution is to lower nominal interest rates by firmly anchoring inflationary expectations through a solidly-credible IT framework.
- The NBR needs to make clear that inflation, not the exchange rate, is its primary objective and to employ interest-rate policy effectively.
- Reunify the headline and effective policy interest rates as soon as possible; bring the effective rate in line with the headline policy rate of 8 percent.
- If fiscal and incomes policies are not tightened, an additional hike in interest rates would most likely be needed.
- Credit and reserve considerations
- Maintain vigilance on rapid credit growth; overly-rapid credit growth magnifies distortions and raises medium-term vulnerabilities.
- Administrative measures on lending are generally ill-suited to macro stabilization; effective supervision is essential following relaxation of some administrative measures.
- Reserve requirements are significantly higher than in other EU members; efforts to lower them should proceed cautiously to avoid adding to macroeconomic imbalances.
Financial Sector and Capital Market Issues
- Soundness and resilience
- Financial soundness indicators suggest the banking sector is well-positioned: high rates of return on equity, high capital adequacy ratios, and moderate NPL ratios.
- NBR stress tests suggest resilience to direct interest rate and exchange rate movements and to a slowdown in growth.
- Vigilance and prudential policy
- Rapid credit growth increases indirect exposures through loan portfolios, requiring high capital ratios and conservative provisioning.
- An FSAP update is welcomed given the changed environment since the 2003 FSAP.
Structural Reforms
- Key reform priorities
- Announce a schedule for increased domestic producer gas prices to achieve import parity.
- Improve efficiency of government spending to support private sector activity.
- Increase labor supply through education, training, and enhanced labor-market flexibility.
- Strengthen efforts to introduce the second pillar on January 1, 2008, while revisiting some parameters of the first pillar.
- Maintain momentum on privatization, including companies in the energy sector and smaller companies.
- Forcefully implement the government's judicial reform agenda to strengthen public administration, reduce corruption, and improve financial discipline and the business climate.
Euro Adoption
- Approach and risks
- Authorities emphasize real convergence prior to euro adoption; this underscores the urgency of structural reforms.
- The envisaged timetable for euro adoption is pragmatic but risks leading to a more gradual implementation of required convergence policies.
- Recommendation: adopt a balanced approach that contains the right incentives for accelerated reform.
Concluding statement of the IMF mission, March 7, 2007.