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Romania: Staff Report for the 2016 Article IV Consultation

Author(s):
International Monetary Fund. European Dept.
Published Date:
May 2016
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Background

1. Romania made important progress in addressing economic imbalances and restoring growth after the global financial crisis. Prudent policies, partly in the context of successive Fund-supported programs, reduced vulnerabilities and the fiscal and current account deficits improved markedly. More recently, the banks’ non-performing loans (NPL) have begun to come down. Per capita income has surpassed pre-crisis levels as growth has been robust and is projected to be amongst the highest in the region in the near term.

Real GDP Growth (projected)

(Percent)

Sources: IMF World Economic Outlook.

2. However, economic policies have weakened recently and hard-won gains are at risk of being reversed. Last year, parliament approved measures with broad political support that are projected to substantially increase the fiscal deficit in 2016 and keep it high in 2017. This stimulus was not needed as consumption growth was already strong. It will also reverse the consolidation trend of recent years and put public debt on a gradually rising trajectory. Recent measures to provide relief to distressed borrowers are not well targeted and could threaten property rights and damage the financial sector. Progress on structural reforms has slowed, constraining potential growth. The current technocratic government took office in November 2015 and the window for passing reforms legislation will narrow in the run up to parliamentary elections before end-2016.

3. Governance problems have received more attention recently and Romania has made progress compared to its peers in the fight against corruption. Corruption is not only a key socio-economic but also a key macroeconomic issue in Romania (Box 1). In recent years, Romania has been recognized for its progress in the fight against corruption and the anticorruption agency has high public opinion ratings. Romania’s position in perception of corruption indicators produced by Transparency International and the World Bank has improved in recent years.

Recent Economic Developments

4. The economy is on a cyclical upswing supported by strong domestic demand. The recent growth pickup was driven mainly by private consumption on the back of recent hikes in minimum and public wages. In addition, record low interest rates, low fuel prices, and a VAT reduction on food items supported consumer confidence and demand (Figure 1). Investment has recently shown some signs of a pickup partly related to a catch-up in EU funds absorption and helped offset a weakening of exports in the second half of the year.

Figure 1.Romania: Real Sector, 2007–16

Sources: Haver Analytics; and IMF staff calculations.

Figure 2.Romania: External Sector, 2007–16

Sources: Haver Analytics; National Bank of Romania, IMF Information Notice System (INS); and IMF staff calculations.

1/ Reserves coverage is based on end-of-year data.

5. Headline inflation has turned negative but underlying inflation—adjusted for recent VAT cuts—is positive and trending up (Figure 4). Annual headline inflation turned negative in June 2015 following a sharp reduction in VAT on food items from 24 to 9 percent. However, adjusting for the VAT changes, underlying inflation has remained positive and been rising, despite the recent fall in international commodity prices and low inflation in the euro area. Although headline inflation may decline in the coming months due to indirect effects from the recent fall in oil prices and VAT reduction, pressure is building on underlying inflation due to a closing output gap, fast wage growth, and a strong fiscal impulse (Annex VI and Selected Issues Paper).

Figure 3.Romania: Labor Market, 2007–16

Sources: Eurostat, Haver Analytics; and IMF staff calculations.

Figure 4.Romania: Monetary Sector, 2007–16

(Percent)

1/ Equals to the percentage of favourable answers minus the percentage of unfavourable answers in the survey on price trends over the next 12-month.

Sources: Haver Analytics; National Bank of Romania; Eurostat; Consensus Forecast; and IMF staff estimates.

Real GDP excluding Agriculture

(year-on-year percent change)

Sources: Haver; and IMF Staff Estimates.

Inflation

(Year-on-year percent change)

1/ Harmonized Index of Consumer Prices (HICP) at constant tax rates.

Sources: Eurostat; and IMF staff estimates.

6. Nominal and real wage growth is accelerating (Figure 3). Overall wages grew by 11.6 percent (y/y) in January 2016, reflecting public wage and minimum wage hikes. Minimum wage is expected to be raised again to 1,250 lei in May 2016 (about €265) from 1,050 lei. These hikes marked a record high for Romania and are the steepest among European peers since 2000. As these exceeded productivity gains, unit labor costs increased by 2.2 percent in 2015 and by 7.6 percent since 2010.

Monthly Minimum Wage 1/

(2005.Q1=100)

Sources: Eurostat, Haver, IMF staff calculations

1/ Data are in real term. Nominal monthly minimum wages are deflated by consumer price indices.

7. The 2015 fiscal deficit maintained the deficit reduction trend of recent years. The general government deficit (on a cash basis) was 1.5 percent of GDP in 2015, compared to 1.8 percent in the original budget. Revenues were 1.3 percent of GDP higher than budgeted as higher income taxes, VAT, and social security contributions more than offset lower EU funds absorption and because of a low base in 2014. Total expenditure was 0.9 percent higher mainly due to personnel spending. Public debt stood at around 40 percent at end-2015. Based on preliminary data, the budget recorded a surplus of 0.4 percent of GDP in the first quarter compared to 0.7 percent in the same period of 2015. The difference reflects mainly lower VAT revenues.

Overall Fiscal Balance

(percent of GDP)

Sources: WEO Live; and IMF staff estimates.

1/ Peer countries include ALB, BIH, BGR, HRV, HUN, UVK, MKD, MNE, POL and SRB.

8. The current account deficit is small and widened modestly in 2015. The main drivers of last year’s deficit were the increase in goods trade deficit and the almost doubling of primary income deficit due to estimated reinvested earnings and interest related to government payments. FDI inflows improved moderately due to the reinvestment of earnings and the recovery of the economy. Despite large repayments to the Fund and the EU, gross reserves of €35.5 billion at end-2015 were broadly adequate by most reserve adequacy metrics (Annex IV). The current account deficit is projected to gradually widen in 2016–17 as domestic demand grows, and reach around 3.5 percent of GDP over the medium term.

Non-performing Loans 1/

(Percent of total loans)

1/ In December 2015, NBR moved from a national definition to an EBA methodology-based definition of NPLs.

Sources: National Bank of Romania; and IMF staff calculations.

Credit Growth

(year-on-year percent change)

Source: National Bank of Romania.

9. Banks’ NPLs have come down markedly and credit is beginning to grow but risks remain. The NPL ratio fell to 14 percent at end-2015 compared to a peak of 22 percent in 2014Q1 reflecting write-offs and sales prompted by the National Bank of Romania’s (NBR) efforts. Credit growth is beginning to turn the cycle, with growth in local currency lending more than offsetting the continued decline in foreign currency lending. The banking system, on average, continues to enjoy comfortable levels of capital adequacy and liquidity, and profitability is improving (Figure 6). Nevertheless, banks remain exposed to credit risk due to FX mismatches in borrowers’ balance sheets and market risk related to large bond holdings. During last summer, four Greek-owned Romanian banks experienced substantial deposit withdrawals. The authorities deftly managed the stress episode and deposit withdrawals have largely been reversed. The NBR has also recently introduced additional capital buffer requirements such as a capital conservation buffer, a countercyclical capital buffer (currently set at zero), a buffer for systemically important institutions, and a systemic risk buffer to enhance the set of macro-prudential tools.

Figure 5.Romania: Fiscal Operations, 2007–17

(Percent of GDP)
(Percent of GDP)

Sources: Romanian authorities; and IMF staff estimates and projections.

Figure 6.Romania: Financial Sector, 2007–15

1/ Excludes credit to central government.

2/ In December, 2015, the NBR moved from a national definition to an EBA methodology-based definition of NPL’s.

Sources: Dxtime; and National Bank of Romania.

Outlook and Risks

10. Staff’s baseline projection is for growth to remain above potential in 2016–17. After a near-term cyclical acceleration driven mostly by domestic consumption and a strong fiscal impulse, growth is expected to return gradually to potential. Given slow progress on structural reforms, staff’s outlook for potential growth in the outer years remains unchanged from the time of the last Article IV consultation. Underlying inflation is expected to gradually pick up and the current account deficit to widen on import growth. Staff’s baseline assumes that the authorities will not exceed 3 percent of GDP deficit in ESA terms (2.8 percent of GDP on a cash basis) as there is a wide level of political consensus to not exceed this threshold, but this would require additional measures.

Macroeconomic Outlook(Percent)
20142015201620172018
Real GDP (yoy)3.03.84.23.63.3
CPI inflation (yoy, eop)0.8−0.91.53.42.7
Unemployment rate (average)6.86.86.46.26.3
(In percent of GDP)
Current account balance−0.5−1.1−1.7−2.5−2.7
Fiscal balance (cash)−1.9−1.5−2.8−2.8−2.8
Gross general government (direct debt only)38.137.037.438.138.7
Gross external debt63.156.758.756.652.7
Sources: Eurostat; Romanian authorities; and IMF staff projections.
Sources: Eurostat; Romanian authorities; and IMF staff projections.

11. Risks to the outlook are tilted to the downside and relate mostly to the pre-electoral environment and external uncertainties (Annex II). Further fiscal stimulus in an election year may boost consumption in the short term but will undermine sustainability of public finances and could dent market sentiment. Inappropriate measures targeting the financial sector that lack proper impact analysis and consultation could harm credit intermediation and investment, and undermine financial stability. On the external side, an abrupt deterioration in emerging market risk perception could trigger currency depreciation and raise the external debt-to-GDP ratio (Annex III). During the recent period of elevated volatility in emerging markets in 2015, Romania experienced sudden capital outflows, though not as pronounced as in regional peers. Maintaining adequate reserve levels, exchange rate flexibility, and fiscal buffers will be key in mitigating risks.

Romania Flows Sensitive to External Conditions

Sources: Flows represent ETFs/Mutual Funds, EPFR.

Output Gap, Wage Growth, and Fiscal Impulse1/

(percent)

Source: IMF staff calculations.

1/ Measured as the annual change in the primary structural general government fiscal deficit.

12. Authorities’ views. The authorities broadly agreed with staff’s views on the near-term outlook and risks but had higher expectations for medium-term growth (above 4 percent during 2017–19). They expected that improved investor confidence and measures to enhance business environment will provide for stronger investment and contribute to higher potential output growth.

Policy Discussions

A. Fiscal Policy

13. Fiscal policy is pro-cyclical and will put public debt on a gradually rising trajectory. The authorities adopted in late 2015 a package of large tax cuts costing 1.4 percent of GDP in 2016 and a further 0.8 percent of GDP in 2017 (table). This includes a reduction of the standard VAT rate from 24 to 20 percent in 2016 and to 19 percent in 2017, and reduction of fuel excises, dividend tax, health contributions and the elimination of the special construction tax.1 Furthermore, several expenditure-expanding measures were introduced, notably ad-hoc salary increases costing 1½ percent of GDP in gross terms. Reflecting this, staff projects the cash deficit to escalate to 3¼ percent in 2017 under current policies, well above the authorities’ cash deficit target of 2.8 percent of GDP for 2016 and 2017.2 Even if the authorities’ deficit path is achieved, public debt will exceed 40 percent of GDP and continue to gradually rise over the medium term.

Revenue Effects from New Tax Code and Public Wage Measures(percent of GDP)
20162017
New tax code−1.4−0.8
Value-added tax−1.0−0.4
Excises0.0−0.3
Personal Income Taxes−0.30.0
Corporate Income Taxes−0.10.0
Property taxation0.0−0.1
Public wage measures1.00.0
(In percent of GDP)
Additional spending1.50.0
Additional revenues (mainly social security contributions)0.50.0
Total effect on the budget2.40.8
Sources: Romanian authorities; and IMF staff calculations.
Sources: Romanian authorities; and IMF staff calculations.
Fiscal Balance Targets(Percent of GDP; cash basis)
201620172018
Budget deficit under current policies (IMF estimate)2.83.33.3
Authorities’ budget target2.82.82.3
Measures needed (cumulative)*0.00.51.0
IMF-recommended budget2.52.01.5
Additional measures needed (cumulative)*0.30.80.8
Sources: Romanian authorities; and IMF staff calculations.

The line “Measures needed (cumulative)” indicates the annual measures starting from 2016 in cumulative terms needed, in the IMF staff’s view, to reach the authorities’ budget target. The 2017 target of 2.8 percent of GDP in cash terms corresponds to around 3 percent in ESA terms. The last line (“Additional measures needed (cumulative)”) indicates in cumulative terms the additional measures needed to bring the deficit from the “Authorities’ budget target” to the “IMF-recommended budget.”

Sources: Romanian authorities; and IMF staff calculations.

The line “Measures needed (cumulative)” indicates the annual measures starting from 2016 in cumulative terms needed, in the IMF staff’s view, to reach the authorities’ budget target. The 2017 target of 2.8 percent of GDP in cash terms corresponds to around 3 percent in ESA terms. The last line (“Additional measures needed (cumulative)”) indicates in cumulative terms the additional measures needed to bring the deficit from the “Authorities’ budget target” to the “IMF-recommended budget.”

Fiscal Balance Targets

(percent of GDP; cash basis)

Sources: Romanian authorities; and IMF staff calculations.

14. Fiscal policy should instead be anchored on a well-defined debt-reduction path. The current fiscal stance implies a structural relaxation of 2¼ percent in 2016 and is inappropriate from demand management perspective and, if unaddressed, risks returning Romania to the detrimental pre-crisis pattern. It also moves Romania away from its Medium-Term Objective (MTO) of 1 percent of GDP deficit (Annex V). Moreover, even though the current level of public debt is not high relative to conventional metrics (Annex III), public debt tripled between 2008 and 2015, showing the vulnerability to a sudden deterioration in public finances and the need for adequate fiscal buffers. The importance of keeping debt on a downward path was emphasized in previous Article IV consultations (Annex I).

Public Debt Dynamics

(Percent of GDP)

Sources: National Authorities; and IMF staff calculations. Note: The line “Budget deficit at 2.8 percent of GDP” is based on a deficit of 2.8 percent of GDP in cash terms (equivalent to 3 percent in ESA terms) from 2016 onwards.

15. Staff recommended gradual adjustment to lower the cash deficit to 1.5 percent of GDP by 2018. The effort should start this year by finding and preserving savings aiming to keep the deficit below 2.5 percent of GDP. For 2017, staff recommended a deficit of 2 percent of GDP. Given relatively low levels of public spending, staff recommends achieving the adjustment by postponing the further tax reductions on VAT and excises scheduled to come into effect next year until other off-setting measures can be identified. This would generate savings of ¾ percent of GDP. As the incremental adjustment recommended for 2017 is ½ percent of GDP, these savings could be used for both achieving the deficit target and addressing other needs such as in the health and education sectors or for the gradual implementation of the unified wage law.3

16. Staff supported the government’s efforts to bolster efficiency and transparency in government spending and public administration. The authorities have made progress in prioritization of large public investment projects—as recommended by the August 2015 TA mission on public financial management—and the mission recommended extending this to cover medium-sized and local government investments. Steps have also been taken to enhance transparency of spending of public entities and the government plans to widen the use of centralized procurement. Staff recommended early passage of the public procurement law that should help to improve accountability and efficiency of public spending. The government also plans to carry out a spending review and staff recommended that the review start with a few pilot sectors to identify room for efficiency gains (see Selected Issues Paper). Targeting of social protection schemes should be strengthened. The approval of the draft law on natural resource taxation will give certainty on the tax framework.

17. The national and sub-national fiscal rules are sound but their enforcement has been weak, undermining the credibility of the fiscal institutions. The Fiscal Responsibility Law (FRL), fiscal council, and fiscal rule follow European standards (Annex V). However, the budget for 2016, approved outside the context of a program with international financial institutions, breaches the fiscal rule. In order to do so, the budget law waived the provisions of the FRL and of the fiscal rule. There is scope to better integrate the Fiscal Council’s work into the decision making of parliament, increase public awareness of the rules, better track the risk of breaching them, and strengthen the automatic sanctions envisaged by the FRL to incentivize responsible parties to apply the rules.

Authorities’ views

18. The authorities agreed with the merits of anchoring fiscal policy on a debt reduction path but believed that next year’s deficit target was achievable without further measures and that there was little appetite in parliament to reduce the deficit further. The authorities agreed with the importance of finding and preserving fiscal savings and were confident that this year’s cash deficit target of 2.8 percent of GDP would be met. For next year, they believed that the deficit target of 2.8 percent was achievable without further measures, unlike under staff projections. They viewed that reducing the 2017 deficit further would require legislative action, such as postponing the further tax reductions on VAT and excises scheduled to come into effect in 2017, for which they expected to find little support in parliament.

B. Structural Reforms

19. A renewed push for structural reforms is needed to improve public and private investment and raise potential growth. These reforms were one of the main focus areas of the most recent Fund-supported program. However, progress was mixed and the program went off track partially because of insufficient progress on structural reforms. While progress has been made to improve governance, other structural reforms have stalled and seem insufficient to raise private investment which remains well below pre-crisis levels. The key challenges are to improve the corporate governance of state-owned enterprises (SOEs), restructure those that have sustained long-standing problems and pose a drain on the budget, raise EU-funds absorption, and improve the investment climate.

20. Staff welcomed recent progress in the fight against corruption and encouraged continued vigor to address remaining challenges.

  • Corruption has been one of the top three obstacles for doing business in Romania according to the World Bank’s and EBRD’s Business Environment and Enterprise Performance survey, holding back investment and growth. It is also associated with lower tax collections as evidenced by Romania’s large VAT gap in the EU (estimated at almost 6 percent of GDP) and misallocation of public resources; in a recent EU survey over half of the companies that participated in a public procurement procedure in the last three years believed there was collusive bidding, conflict of interests in the evaluation of bids, and bribes and kickbacks. Romania is one of two countries in the EU subject to the “cooperation and verification mechanism” to help improve governance.
  • The authorities have undertaken several measures to step up the fight against corruption including passage of a new Criminal and Criminal Procedures Code in 2014, stepping up efforts to investigate and prosecute those suspected of corruption—including high profile figures, expediting the judicial process to secure convictions, and measures to enhance the transparency and efficiency of government spending discussed in ¶16. As a result, Romania’s ranking in corruption indicators has improved. In its most recent assessment released in January 2016, the European Commission (EC) noted that the “track record of the key judicial and integrity institutions to address high-level corruption has remained impressive.”
  • Notwithstanding this progress, further reforms are needed in the areas of public procurement and allocation of public funding, effectiveness of corruption investigations, establishment of conflict of interest rules, and strengthening the National Integrity Agency’s capabilities to monitor asset declarations (Box 1).

Corruption Control and Inflows of Foreign Direct Investment

Sources: World Bank Worldwide Governance Indicators; and IMF World Economic Outlook.

VAT Collections Gap and Corruption Control

Source: World Bank’s Worldwide Governance Indicators (WGI) and European Commission. VAT gap measures the difference between potential and actual VAT collection.

Improving public investment

21. Reforms that improve the efficiency of public investment in critical infrastructure sectors are essential for sustainable growth. SOEs play an important role in the major infrastructure sectors and their improved governance as well as larger involvement of private capital in those sectors remain key reform priorities. Staff recommended early adoption and steadfast implementation of the draft legislation on improving corporate governance of SOEs. Staff also advised to accelerate initial public offerings (IPOs) and the privatization program. All SOEs should be put on a firm financial footing. In some cases aggressive restructuring may be required, and in other cases, liquidation. These reforms would help improve the professionalism of SOEs’ management and resource allocation, raise profitability, reduce subsidies, and contain contingent liabilities for the state. In the energy sector, market deregulation for non-residential consumers has been largely successful and the deregulation of electricity and gas markets for residential consumers should continue.

Net Profit Margin 1/2/

(Percent)

1/ Excludes four highly profitable energy SOEs.

2/ Adjusted for the defense companies arrears clearance in 2014.

Sources: Romanian authorities; and IMF staff estimates.

SOE Activity by Economic Sector, 2014

Sources: Ministry of Public Finance; and IMF staff estimates.

22. Improving absorption of EU funds will boost infrastructure investment. Several actions can help: passing the draft procurement law currently in parliament transposing EU directives, preparing an action plan for the new programming period (2014–20), appropriately preparing documentation to be sent to the EC to avoid delays in processing, and prioritizing projects. Shifting ongoing projects under the previous programming period (2007–13) to the new programming period can increase absorption as some of the steps for their implementation would already have been completed. More generally, there should be a systematic effort to limit domestic financing of projects that qualify for EU funds.

Raising private investment

23. Making regulations and tax administration business friendly will support revenues and help attract private investment, particularly FDI. Overall, Romania ranks 37th out of 189 countries in the 2016 Doing Business rankings (a lower rank signifies better ranking). Nevertheless, there is room for improvement in the areas of construction permits, property registration, protection of minority investors, and tax administration. Regarding the latter, reform efforts should focus on the taxpayers’ single window, electronic filing, consolidation of small taxes, online centralized taxpayer database, and improving timeliness of VAT refunds. In addition, revenue collection will improve if the tax administration agency strengthens its risk-based audit system and large taxpayer unit. The authorities have requested further Fund technical assistance to make progress in this area.

Minimum to Average Wage Ratio 1/

(Percent)

Sources: Eurostat; national authorities, and IMF staff calculations.

1/ 2016 data are based on minimum wage increases announced by the authorities and IMF staff projections. “Peer average” refers to the average for 17 regional countries.

24. Minimum wage rises well beyond productivity gains could do more harm than good (Annex VII and Selected Issues Paper). Minimum wage policy can provide protection to low income workers. However, with the sharp hike planned for this year, the ratio of minimum-to-average wage in Romania will surpass the regional average (chart). This may undermine external competitiveness and hamper job creation, particularly for low-skilled labor and in labor-intensive industries. Staff recommended that the pace of future minimum wage increases be moderate and balance social considerations with competitiveness, productivity growth, and employment prospects. More generally, it would be useful to establish labor market expert committee and periodically reassess the impact of labor market policy including minimum wages.

Authorities’ views

25. The authorities broadly agreed with staff recommendations and hoped to make progress in pending areas. On corruption they emphasized that Romania should be recognized for the progress it has made in the fight against corruption; many other countries in the region had worse corruption indicators and had made less progress. They were hopeful that amendments to the revised law on corporate governance for SOEs and the draft procurement law would be passed soon by parliament. They noted that prospects for IPOs depended on progress in the legal case regarding one of the SOEs. The authorities broadly shared staff’s assessment on minimum wage policy. They have established a working group comprising government officials and social partners to study and make clear guidelines for setting the minimum wage, following the EC’s recommendation. The new mechanism will help to improve the transparency in determining the future level of minimum wage. The working group is expected to present the new proposal by May 2016.

C. Monetary Policy

26. Against the backdrop of declining inflation, policy rate cuts provided significant stimulus in recent years. The policy rate has declined from 6 percent in 2011 to the current 1.75 percent. The NBR also narrowed the interest rate corridor, in line with previous staff advice, and further reduced the minimum reserve requirements (MRRs) on both leu- and FX-denominated liabilities. However, there has been a persistent gap between the interbank and the policy rates which could undermine the effectiveness of the monetary policy framework, as also highlighted in past Fund technical assistance. Easy monetary conditions and a sharp increase in government spending in late 2015 have contributed to a buildup of liquidity in the banking system. Real interest rates, adjusting for underlying inflation, have turned negative.

Interbank Offer Rates

(3 month, percent)

Sources: Haver; Eurostat; National Bank of Romania; and IMF staff calculations.

1/ Computed using the underlying inflation rate, adjusted for VAT changes.

27. While headline inflation is currently negative, underlying inflation, adjusted for recent tax changes, has been rising. Given strong domestic demand, a closing output gap, the large fiscal impulse, and significant wage growth, headline inflation (without policy action) is expected to rise to close to 3½ percent, the upper bound of the variation band of the inflation target, by end-2017 under staff and NBR projections.

Real Wage Growth

(Percent)

Sources: Haver Analytics; and IMF staff calculations.

Inflation Projections 1/

(Annual percent change, period average)

Sources: INS; and IMF staff estimates.

1/ The uncertainty interval was calculated based on the annual CPI inflation forecast errors for Romania from the IMF World Economic Outlook during April 2003–October 2015, following the methodology described in Elekdag and Kannan (2009).

28. Under current inflation projections, staff recommended leaving the policy rate unchanged for now but to begin to reduce the gap between the policy and interbank rates. Given current negative headline inflation, low expected imported inflation, and the uncertainty around inflation expectations, the policy rate can be left unchanged until projected inflation moves more clearly above target. Nonetheless, the NBR should consider signaling a tightening bias and begin to reduce the gap between the market and policy rates by absorbing liquidity and narrowing the interest rate corridor; this will also strengthen the monetary policy framework. Given the large pro-cyclical fiscal impulse, monetary policy may need to shoulder some of the burden for managing domestic demand.

29. In staff’s view the Romanian leu is broadly in line with medium-term fundamentals (Annex IV). Staff’s overall assessment is that Romania’s external position in 2015 was broadly in line with fundamentals. Reserve coverage is broadly adequate according to most reserve adequacy metrics. In line with staff recommendations, the NBR limited interventions in 2015 compared to the previous year. However, the excess liquidity in the domestic market and worsening of global sentiment prompted it to increase FX sales in the latter part of 2015 and in early 2016.

Authorities’ views

30. The authorities noted that monetary policy decisions would depend on NBR Board’s views regarding inflationary pressures and impact on financial markets. They agreed that inflation projections had risen and were approaching the upper bound of the variation band of the inflation target in 2017. Nevertheless, they also pointed out that in the current regional environment of low rates, monetary tightening may prompt short-term capital inflows and hence their preference for a gradual approach to policy normalization. The authorities also shared staff’s view that the Romanian currency is broadly in line with its equilibrium level. They recognized the importance of maintaining adequate reserves, particularly against heightened uncertainty in international financial markets.

D. Financial Sector

31. The authorities need to sustain their efforts to improve bank balance sheets and resist measures that could undermine the stability of the banking system and legal predictability. The recent reduction in NPLs is welcome, and efforts to encourage write-offs and sales of distressed assets should continue. A key near-term risk to bank balance sheets is legislative initiatives that would allow unilateral and retroactive changes to contracts. In April 2016, parliament adopted with broad support a law allowing consumers to unilaterally discharge any debt owed to banks that is collateralized by residential real property through the transfer of the collateral to the creditor (“Giving in Payment” law; Box 2). The intended relief to distressed borrowers is not well targeted and the retroactive application of the law could negatively affect bank balance sheets, undermine private property rights, legal predictability and investor sentiment, and curtail credit provision. Debt relief to distressed borrowers should be targeted including through stringent eligibility requirements while respecting the sanctity of contracts and all such mechanisms should be subject to adequate safeguards. Staff expressed similar concerns about the forced conversion of foreign-currency denominated loans being considered in parliament that would also entail a retroactive change in contracts. In this regard, the authorities should also revisit some elements of existing legislation on abusive clauses in order to dispel another important source of uncertainty, while securing fairness for all stakeholders. Finally, staff recommended putting in place the necessary prerequisites, such as the adequate institutional infrastructure, implementing regulations, or operational systems (e.g., templates), for implementing the recently adopted personal insolvency law.

Private Sector Credit in Selected European Countries

(Percent of GDP)

Sources: Haver Analytics, IMF staff estimates.

Banking Sector Assets and Parent Funding

Sources: Haver Analytics; and National Bank of Romania.

32. A key medium term challenge is to raise financial intermediation to better serve growth needs. Romania has one of the lowest ratios of private credit to GDP in the region and relatively moderate levels of corporate and household debt. Staff analysis suggests that both supply and demand factors have been at play since the 2008 global financial crisis.4 More recently, non-financial corporations’ indicators point to some improvement in liquidity and profitability ratios and household incomes have been on the rise. Nonetheless, raising intermediation is important to help support investment and will require Romania to boost domestic deposits and develop alternative sources of funding for banking sector absent renewed flows from parent banks. The implementation of the recently adopted new covered bond law should contribute to the development of long-term bank funding and intermediation, albeit the “Giving in payment” law enforcement may jeopardize covered bonds issuance. Sustaining the recent progress in NPL reduction will support banks’ ability to cater to credit demand. Results of the ongoing asset quality review would be helpful in this regard to identify the scope of further effort needed in this area.

Corporates Leverage Ratio 1/

1/ Non-financial Corporations Financial Debt to Equity ratio.

Sources: Eurostat; and IMF staff calculations.

Households Leverage Ratio 1/

1/ Households Debt to Net Financial Assets ratio.

Sources: Eurostat; and IMF staff calculations.

33. Significant progress has been made on restructuring the Financial Supervisory Authority (FSA) and strengthening its intervention and resolution tools. This should help address challenges in the insurance sector. The FSA recently implemented comprehensive balance sheet reviews and stress testing exercises which covered virtually the whole insurance sector. The balance sheet reviews revealed a number of deficiencies including capital shortfalls in several insurance companies. The largest insurance company entered bankruptcy in late 2015, while another major insurance company is currently under resolution. Staff welcomed recent progress to strengthen the FSA, including the adoption of recent legislation that strengthens its intervention and resolution tools, and encouraged it to address the revealed shortfalls to ensure adequate capitalization in the insurance sector.

Authorities’ views

34. The authorities broadly agreed with staff’s views. They shared staff’s concerns regarding the potential impact of harmful legislative initiatives and mentioned additional capital buffers as a possible contingency measure. They expressed commitment to further improve the quality of financial intermediaries’ portfolios and ensure that both bank and non-bank financial institutions hold adequate capital. They also agreed that increasing financial intermediation is an important objective for the medium term including through promoting capital market development.

Staff Appraisal

35. Romania made important progress in reducing vulnerabilities after the global financial crisis but the recent weakening of policies puts the gains at risk. The fiscal and current account deficits have improved markedly since the global financial crisis and banks’ loan portfolio quality has strengthened. Stronger policies and fundamentals have helped Romania achieve robust growth and avoid pressures from elevated market volatility. It is important that sound policies and reforms continue to sustain strong and inclusive growth, at a time that downside risks have increased.

36. Fiscal policy needs to put public debt on a downward trajectory. Romania achieved impressive fiscal consolidation since 2009—one of the largest amongst peers. However, the large fiscal relaxation approved last year provides stimulus when consumption growth is already strong. If no further measures are taken, next year’s fiscal deficit will likely breach the EU’s excessive deficit procedure (EDP) threshold. Even if the deficit is kept at the authorities’ cash budget target of 2.8 percent of GDP (3 percent in ESA terms), public debt will exceed 40 percent of GDP and continue to gradually rise. Instead, gradual adjustment to reduce the cash deficit to 1½ percent of GDP by 2018 will help keep debt on a downward path. Postponing the tax reductions scheduled to come into effect in 2017 will help achieve this goal.

37. More broadly, the credibility of fiscal institutions should be strengthened. The waiving of the provisions of the FRL and the fiscal rule undermines the credibility of the policy framework and the budget process. In this regard, it is important that the work of the Fiscal Council is integrated better into decision making.

38. Reforms should be accelerated to make public administration more efficient and transparent. These reforms include further progress in prioritization of public investment projects, fully operationalizing the recently created spending review unit, strengthening targeting of social protection schemes, extending centralized procurement to generate savings, and passage of the public procurement law. Recent efforts to enhance transparency of spending of public entities are welcome and should help to improve accountability and efficiency of public spending. Early passage of legislation on natural resource taxation will help to give certainty on the tax framework.

39. Continued structural reform efforts are needed to improve public and private investment and raise potential growth. The efficiency of public investment in critical infrastructure sectors can be enhanced by strengthening the corporate governance of SOEs—including through the passage of draft legislation in parliament—and better planning and utilization of EU funds. The tax administration agency should focus more on high revenue potential tax payers while becoming more business friendly. Reforms need to focus on taxpayers’ single window, electronic filing, consolidation of small taxes, online centralized taxpayers’ database, and improving promptness of VAT refunds.

40. There has been welcome progress in the fight against corruption and more needs to be done. Improving governance and the fight against corruption are not only key socio-economic issues, they are also macro-relevant in Romania. The anticorruption agency enjoys growing public confidence and efforts in this direction should be sustained.

41. Policies for public and minimum wages should take into account fiscal space and competitiveness considerations. On public sector wages, there is a need to eliminate the distortions in the remuneration system. Current budget plans do not provide fiscal space for the unified wage law that would help address these distortions. Postponement of the 2017 tax reductions would provide space for the phased implementation of this law. On minimum wage, moderating the pace of future increases will help balance social considerations with competitiveness, productivity growth, and employment prospects.

42. A tightening bias in monetary policy is warranted on current inflation projections. Inflation projections have risen to the upper bound of the variation band of the central bank’s inflation target on account of a closing output gap, sharp wage increases, and the fiscal stimulus. While the policy rate can be left unchanged until projected inflation moves more clearly above target, the NBR should begin to reduce the gap between the market and policy rates by absorbing liquidity from the market and narrowing the interest rate corridor. Interventions in the foreign exchange market should be limited to smoothing excessive volatility.

43. There has been important progress in reducing NPLs and threats to financial stability need to be guarded against. Sustained efforts towards reducing NPLs are welcome. Removing provisions in legislative initiatives that could undermine financial stability and legal predictability, and finding better ways to target relief to distressed borrowers, will mitigate risks. Increasing financial intermediation while maintaining financial sector stability will support growth needs.

44. It is recommended to hold the next Article IV consultation on the standard 12-month cycle.

Box 1.Romania’s Recent Anticorruption Campaign

Corruption issues are highly macro-relevant in Romania. They affect three areas in particular: government revenues, government expenditure, and competitiveness and FDI.

i) Corruption undermines government revenue. It can lead to foregone tax revenue, as evidenced for example by Romania’s VAT gap being the largest in the EU. Corruption is also associated with larger unofficial activity. The size of the shadow economy in Romania was estimated to be 28 percent of GDP in 2014, which is the second highest percentage in the EU. A large shadow economy leads to reduced state revenues which in turn reduce the quality and quantity of goods and services publicly provided.

ii) Corruption can lead to a suboptimal composition of government expenditure. It induces government officials to choose expenditure on the basis of opportunities for inflating spending and obtaining more rents instead of public welfare. Thus, it can bloat the budget for domestically financed capital spending with low effectiveness as shown by the slow pace of infrastructure deployment (see the 2015 Selected Issues Papers). Public procurement represents an important share of the Romanian economy. Public works, goods and services constituted about 12 percent of GDP in Romania in 2015 and, as shown by a number of external audits, there is still a general perception of high levels of corruption. The deficient application of public procurement rules triggers substantial financial corrections and contributes to a low absorption of EU funds. As highlighted by the EU anticorruption report, businesses report a number of widespread practices, including the involvement of bidders in the design of proposal specifications, conflicts of interest in the evaluation of bids, specifications being tailor made for particular companies, and the abuse of noncompetitive or fast-track procedures. There is a high perception that public funds are being diverted and frequent experiences of irregular payments and bribes. An earlier World Bank survey showed that state sector entities with better systems of public administration tended to have lower levels of corruption.

DNA Announcements of the Politically-Connected Cases

Source: Political Corruption in Romania, DNA Database.

iii) Finally, corruption depresses foreign direct investment and is a key obstacle to Romania’s competitiveness. Corruption is one of the top three obstacles for doing business in the World Bank’s and EBRD’s Business Environment and Enterprise Performance survey. At a cross-country level several studies have demonstrated the negative effects of corruption on growth. Ugur (2014) shows that corruption has a negative effect on per-capita GDP growth, even after controlling for possible biases in the underlying empirical analyses. Ugur and Dasgupta (2011) find that a one-unit improvement in the perceived corruption index can lead to an increase of 0.59 to 0.86 percentage-points in the growth rate of per-capita GDP, depending on the sample of countries analyzed.

Romania has recently been recognized for its anticorruption efforts and these efforts should be sustained. The country’s anticorruption agency (DNA) has increasingly been recognized by international agencies and in international media for its fights against corruption. In its most recent assessment released in January 2016, the EC described the “track record of the key judicial and integrity institutions to address high-level corruption has remained impressive.”

In the course of 2015 alone, DNA indicted over 1,250 defendants, and this included the prime minister, former ministers, members of parliament, mayors, presidents of county councils, judges, prosecutors and a wide variety of senior officials. It has also increased its interim asset freezing measures relating to these cases, to reach a figure of €452 million. Anecdotal reports suggest that one reason behind last year’s investment under-spending was fear of being caught in the recent anticorruption effort. Public confidence in the institution has jumped, as also reflected in opinion polls.

Romania needs to do more in its anticorruption fight and sustaining recent momentum will have big payoffs. The most recent CVM report stressed that while there have been steps to tackle general corruption, further consolidation of reform is needed to ensure the irreversibility of progress. The report suggests strengthening of prevention and control mechanisms with regard to public procurement and public contracts, including in state-owned companies, as well as strengthening safeguards when it comes to allocation of public funding. Similarly, in its January 2016 Report, the Council of Europe’s Group of States against Corruption (GRECO) commended the country’s progress in enhancing the anticorruption framework. It nevertheless recommended several anticorruption measures, including the provision of a transparent system for lifting parliamentary immunity for corruption investigations, establishment of conflicts of interest rules for parliamentarians, and strengthening the National Integrity Agency’s capabilities to monitor asset declarations. Finally, ensuring that the AML/CFT regime with respect to domestic politically exposed persons is in line with the international standard and effectively implementing AML/CFT tools could also support efforts to prevent, deter and detect laundering of corruption proceeds.

Making progress on anticorruption will directly support many of the Fund’s policy recommendations and, vice versa, many of the Fund’s policy recommendations will help with the anticorruption efforts. Anticorruption and, more broadly governance, is an overarching issue that would support progress in many of the Fund’s recommendations. It would support spending efficiency, particularly in the health and education sectors, as discussed in the accompanying Selected Issues Paper. Adopting procurement reform will similarly go hand in hand with the anticorruption efforts. The Fund’s recommendations for a unified wage law would help reduce the incentives of public employees to seek compensation through corruption. Improving the corporate governance of the SOE sector would help reduce a big source of patronage, improve efficiency, and allow saved public resources to be used elsewhere. Finally, bringing tax evaders in the tax net will allow the government to reduce the pro-cyclicality of the budget, help resume the deficit reducing trend, and raise the incentive of those already in the tax net to contribute their share.

Box 2.Debt Discharge (Giving in Payment) Law

The Romanian banking sector faces risks associated with potentially harmful legislative initiatives that allow unilateral and retroactive change of contracts. One such initiative is the law on the discharge of debt obligations assumed through credit agreements through the transfer of mortgaged property (“Giving in Payment” law). The law was first approved by the parliament in November 2015; however, President Iohannis sent the bill back to the parliament for reconsideration. In April 2016 the parliament approved the law in a final vote.

The “Giving in Payment” law contains a number of controversial provisions that could be potentially detrimental to the economy. While the law was presented as a measure to help distressed households with mortgages, Romanian banks and the NBR have argued that some of the provisions can create legal uncertainties and moral hazard and may pose systemic risk to banks. The law permits consumers as well as their co-debtors and pledgors meeting the following criteria to discharge their loans in entirety through the transfer of the collateral to the creditors: (i) the loan is less than 250,000 euros at origination; (ii) the loan is collateralized by residential real property; and (iii) the creditors are credit institutions, non-bank financial institutions or their assignees. Should the right be exercised by the debtor, the creditor would no longer have recourse to any other assets or income of the debtor beyond the pledged collateral in case of any deficiency claim. The law applies not only to new loans but also to existing ones, including in situations where property was foreclosed in the past or foreclosure proceedings are ongoing. It does not specify any other economic or other eligibility criteria for borrowers and does not appear to take into account the borrower’s ability to pay. The ECB noted that the draft law introduces unprecedented changes into the legal framework applicable to credit agreements in Romania and will significantly undermine legal certainty and the adequate management of credit risk in financial institutions.1 The EC in its latest country report on Romania has also expressed major concerns including regarding the retroactive applicability of the law.

Mortgage-Backed Loans 1/(end-February 2016)
Residential mortgagesHousing developmentConsumer loansTotal
Loan agreements (thous.)99.075.8168.3343.2
Number of loans overdue 30+ days (thous.)4.74.817.627.1
Outstanding loans (billion lei)15.710.220.946.8
Loans overdue 30+ days (billion lei)0.90.93.04.7
Share of overdue loans (percent)5.98.514.110.1
Sources: National Bank of Romania; and IMF staff calculations.

Excludes loans extended under Prima Casa and loans with amounts in excess of euro 250,000 at origination.

Sources: National Bank of Romania; and IMF staff calculations.

Excludes loans extended under Prima Casa and loans with amounts in excess of euro 250,000 at origination.

The application of the law may lead to substantial losses for banks and undermine payment culture and future access to credit. While it is hard to provide reliable estimates of the potential impact of the law due to both legal and behavioral uncertainties, some available data allows gauging the possible magnitude of such an impact. The amount of overdue loans which would be eligible for an application under the law is not very high at around RON 5 billion which could be the lower limit of the amount the banks would have to write-off (the write-offs would be smaller by the amount of provisions for overdue loans but such data was not available). In addition, there may be “underwater mortgage” cases where borrowers who are still current on their payments, and have the ability to continue making payments, may choose to use the provisions of the “Giving in Payment” law to receive a discharge of any deficiency claim and transfer the entire collateral risk to the bank. A hypothetical assumption of 20 percent of total loans being loans where borrowers decide to take advantage of the law because they have “underwater mortgages” would add RON 8 billion to the amount of possible write-offs. Thus, the amount of potential write-offs could be in the range of RON 5–13 billion. Applying a further assumption that the banks incur a loss of 25 percent of the loan value when they sell the underlying immovable property, the overall loss to banks could be in the range of RON 1.3–3.3 billion (up to 4 percent of commercial banks total capital). These estimates could be higher if there is significant use of “Giving in Payment” law. The banks will also incur additional operational expenses in order to manage and sell the portfolio of immovable property that they will take on their balance sheets. Besides the direct impact of the law on bank balance sheets, a key negative spillover from the law would be that it could undermine future credit expansion and investor confidence by making the legal framework less predictable. There are also risks that contingent liabilities are created for the state in case banks go to courts and claim compensation from the Romanian state.

1 See ECB opinion of December 18, 2015: https://www.ecb.europa.eu/ecb/legal/pdf/en_con_2015_56_f_sign.pdf.

Figure 7.Romania: Financial Developments, 2013–16

Sources: Bloomberg; and Haver Analytics.

Figure 8.Romania and Peer Countries: Financial Soundness Indicators, 2010–15 1/

Sources: Haver Analytics; and National Bank of Romania.

1/ Unweighted average of Bulgaria, Croatia, Czech Republic, Hungary, Poland, Slovakia and Slovenia.

2/ In December 2015, the NBR moved from a national definition to an EBA methodology-based definition of NPL’s.

Table 1.Romania: Selected Economic and Social Indicators, 2010–17
20102011201220132014201520162017
Prel.Proj.Proj.
Output and prices(Annual percentage change)
Real GDP−0.81.10.63.53.03.84.23.6
Contributions to GDP growth
Domestic demand−0.71.1−0.4−0.13.25.36.24.8
Net exports−0.1−0.11.13.6−0.2−1.5−1.7−1.2
Consumer price index (CPI, average)6.15.83.34.01.1−0.6−0.43.1
Consumer price index (CPI, end of period)8.03.14.91.60.8−0.91.53.4
Core price index (CPI, end of period)4.12.43.3−0.21.1−3.12.63.6
Producer price index (average)4.47.15.42.1−0.1−2.2
Unemployment rate (average)7.07.16.87.16.86.86.46.2
Nominal wages2.54.95.05.05.38.59.47.1
Public sector wages−10.8−2.56.811.92.310.116.15.5
Private sector wages7.47.24.43.26.18.07.87.5
Saving and Investment(In percent of GDP)
Gross domestic investment26.827.926.825.625.225.624.624.8
Gross national savings21.822.922.124.524.824.522.922.3
General government finances 1/
Revenue31.632.132.431.432.032.830.729.5
Expenditure37.936.334.933.933.934.233.532.3
Fiscal balance−6.3−4.2−2.5−2.5−1.9−1.5−2.8−2.8
External financing2.82.73.22.11.9−0.51.01.3
Domestic financing3.51.5−0.81.41.21.11.51.5
Primary balance−5.0−2.8−0.7−0.8−0.4−0.2−1.5−1.3
Structural fiscal balance 2/−6.1−3.4−1.7−1.7−0.5−0.7−3.0−2.7
Gross public debt (including guarantees)30.533.937.638.840.539.339.540.1
Money and credit(Annual percentage change)
Broad money (M3)6.96.62.78.88.49.39.58.0
Credit to private sector4.76.61.3−3.3−3.33.04.14.6
Interest rates, eop 3/(In percent)
NBR policy rate6.256.05.254.02.501.751.75
NBR lending rate (Lombard)10.2510.09.257.04.754.253.25
Interbank offer rate (1 week)3.66.05.91.80.70.60.4
Balance of payments(In percent of GDP)
Current account balance−5.1−4.9−4.8−1.1−0.5−1.1−1.7−2.5
Merchandise trade balance−7.6−7.0−6.9−4.0−4.2−4.8−5.6−6.3
Capital account balance0.20.51.42.12.62.41.51.4
Financial account balance−2.0−2.0−2.6−3.00.10.8−0.6−1.7
Foreign direct investment balance−1.8−1.3−1.9−2.0−1.8−1.7−1.8−1.8
International investment position−62.3−64.2−67.8−61.7−56.9−50.9−48.6−46.5
Gross official reserves28.327.926.524.623.622.121.921.7
Gross external debt72.974.074.668.063.156.758.756.6
Exchange rates 3/
Lei per euro (end of period)4.34.34.44.54.54.54.5
Lei per euro (average)4.24.24.54.44.44.4
Real effective exchange rate
CPI based (percentage change)2.02.9−6.04.70.2−3.7
GDP deflator based (percentage change)1.31.8−4.84.10.9−0.3
Memorandum Items:
Nominal GDP (in bn RON)533.9565.1595.4637.5667.6712.8757.1802.5
Potential output growth2.01.92.12.33.03.03.23.3
Social and Other Indicators
GDP per capita: US$9,995 (2014); GDP per capita, PPP: current international $19,801 (2014)
People at risk of poverty or social exclusion: 39.5% (2014)
Sources: Romanian authorities; IMF staff estimates and projections; World Development Indicators database, Eurostat.

General government finances refer to cash data.

Fiscal balance (cash basis) adjusted for the automatic effects of the business cycle and one-off effects.

For 2016: data as of April 20.

Sources: Romanian authorities; IMF staff estimates and projections; World Development Indicators database, Eurostat.

General government finances refer to cash data.

Fiscal balance (cash basis) adjusted for the automatic effects of the business cycle and one-off effects.

For 2016: data as of April 20.

Table 2.Romania: Medium-Term Macroeconomic Framework, Current Policies, 2012–21
2012201320142015201620172018201920202021
Prel.Proj.Proj.Proj.Proj.Proj.Proj.
GDP and prices (annual percent change)
Real GDP0.63.53.03.84.23.63.33.33.33.3
Agriculture 1/−26.133.72.4−9.4
Non-Agriculture 1/2.52.13.04.4
Real domestic demand−0.4−0.13.15.36.14.53.83.53.43.4
Consumption1.1−0.33.15.26.14.53.63.43.33.4
Investment0.1−5.42.58.84.34.64.33.73.83.4
Exports1.019.78.65.55.96.06.26.26.26.2
Imports−1.88.88.99.19.07.76.96.46.26.2
Consumer price index (CPI, average)3.34.01.1−0.6−0.43.13.02.72.62.5
Consumer price index (CPI, end of period)4.91.60.8−0.91.53.42.72.72.62.5
Saving and investment (in percent of GDP)
Gross national saving22.124.524.824.522.922.322.222.021.821.7
Gross domestic investment26.825.625.225.524.624.824.925.125.225.2
Government5.85.65.76.24.94.54.14.24.14.0
Private21.020.019.519.319.820.320.820.921.121.2
General government (in percent of GDP)
Revenue32.431.432.032.830.729.529.129.028.828.7
Expenditure34.933.933.934.233.532.331.831.831.631.5
Fiscal balance 2/−2.5−2.5−1.9−1.5−2.8−2.8−2.8−2.8−2.8−2.8
Structural fiscal balance 3/−1.7−1.7−0.5−0.7−3.0−2.7−2.6−2.7−2.7−2.7
Gross general government debt (direct debt only)35.336.538.137.037.438.138.739.440.140.7
Gross general government debt (including guarantees)37.638.840.539.339.540.140.541.241.842.3
Monetary aggregates (annual percent change)
Broad money (M3)2.78.88.49.39.58.07.06.06.06.0
Credit to private sector1.3−3.3−3.33.04.14.64.34.14.04.0
Balance of payments (in percent of GDP)
Current account−4.8−1.1−0.5−1.1−1.7−2.5−2.7−3.0−3.4−3.5
Trade balance−6.9−4.0−4.2−4.8−5.6−6.3−6.4−6.7−7.0−7.1
Services balance1.93.33.94.33.93.93.94.04.04.0
Income balance−1.7−2.2−1.3−2.4−2.0−2.0−2.1−2.1−2.2−2.2
Transfers balance2.01.91.11.81.92.01.91.81.71.8
Capital account balance1.42.12.62.41.51.41.11.01.00.9
Financial account balance−2.6−3.00.10.8−0.6−1.7−2.8−3.1−3.7−4.0
Foreign direct investment, balance−1.9−2.0−1.8−1.7−1.8−1.8−1.8−1.8−1.8−1.8
Memorandum items:
Gross international reserves (in billions of euros)35.435.435.535.536.738.640.843.045.347.3
Gross international reserves (in months of next year’s imports)7.36.86.46.25.95.75.75.75.75.7
International investment position (in percent of GDP)−67.8−61.7−56.9−50.2−48.6−46.5−45.4−45.0−44.9−45.1
External debt (in percent of GDP)74.668.063.156.758.756.652.748.945.642.4
Short-term external debt (in percent of GDP)15.713.312.612.412.111.711.110.59.99.3
Terms of trade (merchandise, percent change)−3.40.40.91.20.0−0.10.6−0.3−0.5−0.2
Nominal GDP (in billions of lei)595.4637.5667.6712.8757.1802.5850.7898.6949.71,005.2
Output gap (percent of potential GDP)−2.6−1.5−1.5−0.80.10.40.30.20.10.0
Potential GDP (percent change)2.12.33.03.03.23.33.33.33.33.3
Sources: Romanian authorities; and IMF staff estimates and projections.

Based on gross value added data from the National Institute of Statistics (NIS) in Romania. Note that there is a small discrepancy between the supply side GDP data from the NIS and the demand side data from Eurostat.

Includes in 2011–12, the National Program for Infrastructure Projects (PNDI), which was cancelled thereafter.

Actual fiscal balance adjusted for the automatic effects related to the business cycle and one-off effects.

Sources: Romanian authorities; and IMF staff estimates and projections.

Based on gross value added data from the National Institute of Statistics (NIS) in Romania. Note that there is a small discrepancy between the supply side GDP data from the NIS and the demand side data from Eurostat.

Includes in 2011–12, the National Program for Infrastructure Projects (PNDI), which was cancelled thereafter.

Actual fiscal balance adjusted for the automatic effects related to the business cycle and one-off effects.

Table 3.Romania: Balance of Payments, 2010–17(In billions of euros, unless otherwise indicated)
20102011201220132014201520162017
Prel.Prel.Proj.Proj.
Current account balance−6.4−6.6−6.4−1.5−0.7−1.8−2.9−4.4
Merchandise trade balance−9.6−9.4−9.3−5.8−6.3−7.8−9.4−11.1
Exports (f.o.b.)32.740.139.943.946.849.148.952.4
Imports (f.o.b.)42.449.549.249.753.156.958.263.6
Services balance1.51.72.54.75.96.96.66.9
Exports of non-factor services7.88.79.913.415.116.816.617.9
Imports of non-factor services6.37.07.48.79.29.810.111.0
Primary income, net−1.5−1.7−2.3−3.1−1.9−3.8−3.4−3.6
Receipts1.41.92.22.52.22.42.52.6
Payments2.93.64.55.64.16.25.86.2
Secondary income, net3.22.82.72.71.72.83.23.5
Capital account balance0.20.71.93.04.03.92.62.5
Financial account balance−2.5−2.7−3.4−4.40.21.3−1.0−3.1
Foreign direct investment balance−2.3−1.7−2.6−2.9−2.7−2.8−3.0−3.3
Portfolio investment balance−0.9−1.6−3.4−5.5−2.90.7−1.7−2.3
Other investment balance0.70.62.54.05.83.43.82.5
General government−0.10.40.40.90.40.51.21.5
Domestic banks−1.00.22.22.54.12.11.90.9
Other private sector1.80.0−0.10.71.30.80.60.1
Errors and omissions0.71.11.20.2−0.20.80.00.0
Multilateral financing3.73.51.00.70.3−0.8
European Commission2.21.40.0
World Bank0.00.70.00.70.30.8
EIB/EBRD/IFC1.51.41.0
Overall balance0.71.41.16.83.20.80.61.1
Financing−0.7−1.4−1.1−6.8−3.2−0.8−0.6−1.1
Gross international reserves (“-”: increase)−3.5−0.91.5−2.11.20.6−1.3−1.8
Use of IMF credit, net4.30.9−1.6−4.6−4.4−1.4−0.10.0
Purchases 1/4.30.90.00.00.00.00.00.0
Repurchases0.00.0−1.6−4.6−4.4−1.4−0.10.0
Other liabilities, net0.00.00.00.00.00.00.00.0
Memorandum items:(In percent of GDP)
Current account balance−5.1−4.9−4.8−1.1−0.5−1.1−1.7−2.5
Foreign direct investment balance−1.8−1.3−1.9−2.0−1.8−1.7−1.8−1.8
Merchandise trade balance−7.6−7.0−6.9−4.0−4.2−4.8−5.6−6.3
Exports25.830.129.930.431.230.629.229.5
Imports33.437.136.834.435.435.534.835.8
Gross external financing requirement26.929.233.931.627.726.225.423.5
(Annual percent change)
Terms of trade (merchandise)1.31.8−3.40.40.91.20.0−0.1
Export volume15.211.91.019.78.66.35.96.0
Import volume12.610.2−1.88.88.98.39.07.7
Export prices7.87.3−5.2−1.1−1.5−1.8−6.11.2
Import prices6.74.61.1−9.11.8−1.0−6.11.3
(In billions of euros)
Gross international reserves 2/36.037.335.435.435.535.536.738.6
Excluding IMF credit24.725.324.429.535.535.436.738.6
of which: Excluding banks’ required reserves29.3
GDP126.8133.3133.6144.3150.2160.4167.4177.6
Sources: Romanian authorities; and IMF staff estimates and projections.

Includes IMF disbursement to the Treasury of €0.9 billion in 2009 and €1.2 billion in 2010.

Operational definition, reflecting valuation effects and the allocation of SDR 908.8 million that was made available in two tranches in August and September 2009.

Sources: Romanian authorities; and IMF staff estimates and projections.

Includes IMF disbursement to the Treasury of €0.9 billion in 2009 and €1.2 billion in 2010.

Operational definition, reflecting valuation effects and the allocation of SDR 908.8 million that was made available in two tranches in August and September 2009.

Table 4.Romania: Gross External Financing Requirements, 2012–17(In billions of euros, unless otherwise indicated)
201220132014201520162017
Proj.Proj.
I. Total financing requirements44.049.848.247.434.534.8
I.A. Current account deficit5.81.30.71.82.94.4
I.B. Short-term debt25.822.221.019.820.421.0
Public sector7.58.69.18.57.07.0
Banks14.19.07.87.79.29.7
Corporates4.24.64.03.74.24.4
I.C. Maturing medium- and long-term debt12.126.525.824.810.79.4
Public sector2.815.217.715.42.61.7
Banks4.96.53.95.94.24.2
Corporates4.44.84.23.63.93.5
I.D. Other net capital outflows 1/0.3−0.20.81.00.50.0
II. Total financing sources42.356.351.248.935.237.1
II.A. Foreign direct investment, net2.23.12.72.83.03.3
II.B. Capital account inflows1.93.24.03.92.62.5
II.C. Short-term debt23.322.419.621.520.921.6
Public sector6.78.19.38.37.07.0
Banks12.19.06.49.09.510.0
Corporates4.55.23.94.24.44.6
II.D. Medium- and long-term debt14.927.525.020.78.79.8
Public sector6.720.519.515.13.13.6
Banks5.13.82.43.02.42.9
Corporates3.13.23.12.53.13.2
Errors and omissions0.9−0.4−0.20.20.00.0
III. Increase in gross international reserves−1.42.1−1.2−0.61.31.8
IV. Financing gap−0.6−3.9−4.1−2.30.6−0.5
V. Program financing−0.6−3.9−4.1−2.30.6−0.5
IMF 2/−1.6−4.6−4.4−1.5−0.10.0
Purchases0.00.00.00.00.00.0
Repurchases−1.6−4.6−4.4−1.5−0.10.0
European Commission0.00.00.0−1.50.0−1.2
Disbursements0.00.00.00.00.00.0
Principal repayments0.00.00.0−1.50.0−1.2
Others1.00.70.30.80.80.7
World Bank0.00.70.30.80.80.7
EIB/EBRD/IFC1.0
Memorandum items:
Rollover rates for amortizing debt ST (in percent)
Public sector909510299100100
Banks8510082117103104
Corporates10711396114104104
Rollover rates for amortizing debt MLT (in percent)
Public sector24013411198120217
Banks1045960525970
Corporates716774718192
Rollover rates for total amortizing debt (in percent)
Public sector13112010898105123
Banks908375898994
Corporates899085939399
Gross international reserves 3/35.435.435.535.536.738.6
Coverage of gross international reserves
− Months of imports of GFNS (next year)7.36.86.46.25.95.7
− Short-term external debt (in percent)80.386.688.389.698.799.4
Sources: Romanian authorities; and IMF staff estimates and projections.

Includes portfolio equity, financial derivatives and other investments.

SDR interest rate as well as exchange rate of SDR/US$ and US$/€ of January 15, 2015.

Operational definition.

Sources: Romanian authorities; and IMF staff estimates and projections.

Includes portfolio equity, financial derivatives and other investments.

SDR interest rate as well as exchange rate of SDR/US$ and US$/€ of January 15, 2015.

Operational definition.

Table 5a.Romania: General Government Operations, 2010–17 1/(In percent of GDP)
20102011201220132014201520162017
Prelim.Proj.Proj.
Revenue31.632.132.431.432.032.830.729.5
Taxes26.027.627.827.227.427.526.125.1
Corporate income tax2.12.02.01.92.02.12.02.0
Personal income tax3.43.43.53.63.53.83.63.6
VAT7.48.58.58.17.68.06.96.6
Excises3.23.43.43.33.63.63.63.2
Customs duties0.10.10.10.10.10.10.10.1
Social security contributions8.69.08.78.58.68.18.18.1
Other taxes1.31.21.61.71.81.71.81.5
Nontax revenue3.73.23.12.72.62.72.62.5
Capital revenue0.10.10.10.10.20.10.10.1
Grants, including EU disbursements1.81.21.41.41.72.41.81.7
Expenditure37.936.334.933.933.934.233.532.3
Current expenditure34.332.331.831.231.531.830.930.2
Compensation of employees8.06.86.97.37.57.37.67.4
Goods and services5.55.65.86.15.95.75.75.6
Interest1.41.61.81.71.51.31.51.5
Subsidies1.31.11.00.80.90.90.90.8
Transfers17.816.816.115.315.516.515.314.8
Pensions7.98.48.17.77.77.26.86.7
Other social transfers5.03.63.23.02.93.43.73.5
Other transfers 2/4.44.34.34.04.25.34.33.9
Other spending0.50.60.50.50.60.60.50.5
Projects with external credits0.30.40.30.10.10.10.10.1
Capital expenditure 3/3.64.13.22.82.62.62.62.1
Reserve fund0.00.00.00.00.00.00.00.0
Net lending and expense refunds−0.1−0.1−0.1−0.2−0.1−0.10.00.0
Fiscal balance−6.3−4.2−2.5−2.5−1.9−1.5−2.8−2.8
Primary balance−5.0−2.8−0.7−0.8−0.4−0.2−1.5−1.3
Financing6.34.22.52.51.91.52.82.8
External borrowing (net)2.82.73.22.11.9−0.51.01.3
Domestic borrowing (net)3.92.20.91.41.21.11.51.5
Use of deposits−0.4−0.7−1.7−1.0−1.31.30.30.0
Privatization proceeds0.10.00.00.00.00.00.00.0
Financial liabilities
Gross general-government debt 4/30.533.937.638.840.539.339.540.1
Gross general-government debt excl. guarantees27.631.835.336.538.137.037.438.1
External12.715.117.018.020.018.618.618.8
Domestic14.916.718.318.518.218.418.819.2
Memorandum items:
Total capital spending7.17.66.45.65.36.25.34.5
Fiscal balance (ESA95 basis)−6.7−5.6−3.7−2.1−0.9−0.7−3.0−2.9
Gross general government debt (ESA95 basis)29.934.237.438.039.838.439.2
Output gap 5/−0.4−1.3−2.6−1.5−1.5−0.80.10.4
Cyclically adjusted balance 6/−6.1−3.7−1.6−2.0−1.4−1.2−2.9−2.9
CAPB 6/−4.8−2.20.2−0.30.20.2−1.4−1.4
Structural fiscal balance (ESA95 basis) 6/−3.2−2.8
Structural fiscal balance 6/−6.1−3.4−1.7−1.7−0.5−0.7−3.0−2.7
Gross general government debt (authorities definition) 7/36.439.540.541.944.344.3
Nominal GDP (in billions of lei)533.9565.1595.4637.5667.6712.8757.1802.5
Sources: Ministry of Public Finance; Eurostat; and IMF staff estimates and projections.

Unless otherwise noted, the table is on a cash basis following GFSM 86. The general government is composed of the central government, local governments, social security funds, and the road fund company.

Includes EU-financed capital projects.

Does not include all capital spending.

Total consolidated general-government debt, including state government debt, local government debt, and guarantees.

Percentage deviation of actual from potential GDP.

Expressed in percentage of potential GDP.

Includes guarantees and intra-governmental debt.

Sources: Ministry of Public Finance; Eurostat; and IMF staff estimates and projections.

Unless otherwise noted, the table is on a cash basis following GFSM 86. The general government is composed of the central government, local governments, social security funds, and the road fund company.

Includes EU-financed capital projects.

Does not include all capital spending.

Total consolidated general-government debt, including state government debt, local government debt, and guarantees.

Percentage deviation of actual from potential GDP.

Expressed in percentage of potential GDP.

Includes guarantees and intra-governmental debt.

Table 5b.Romania: General Government Operations, 2010–17(In millions of lei)
20102011201220132014201520162017
Prelim.Proj.Proj.
Revenue168,635181,567193,148200,038213,834233,554232,127236,776
Taxes138,667155,710165,702173,489182,586195,906197,767201,781
Corporate income tax10,96911,03011,82612,19113,68414,80315,23416,119
Personal income tax17,95719,46120,95622,73623,69227,28827,12729,130
VAT39,24647,91750,51651,82750,87957,13252,31952,737
Excises17,31219,10520,26021,10624,09526,01827,16525,518
Customs duties574674707620643816850926
Social security contributions45,70450,63751,65854,37957,61257,60461,50265,308
Other taxes6,9056,8859,77810,63011,98212,24513,57012,042
Nontax revenue19,79618,21718,32817,15317,18819,49519,40420,103
Interest Revenue595718279182157743789377
Capital revenue6857666536501,073918957991
Grants9,4946,8748,4229,11211,18916,98414,00013,901
o/w EU pre-accession funds4,05476544320115600
Financial operations and other−6043−3651,79825000
Expenditure202,256205,277207,921215,810226,327243,915.5253,559259,010
Current expenditure183,243182,709189,274198,957210,136226,688234,077242,375
Compensation of employees42,83938,49640,79946,29950,24752,02657,33559,581
Goods and services29,54131,64334,44438,58039,58240,80843,11144,949
Interest7,2758,88310,71010,74910,1999,57211,06912,079
Subsidies6,7356,4076,1225,1506,0946,2756,4646,664
Transfers95,06095,17295,58597,310103,422117,552115,564118,536
Pensions42,10747,46948,05149,37451,53951,53951,70754,118
Other social transfers26,50520,53918,99719,00519,66324,40727,66628,458
Other transfers 1/23,51424,04925,56925,71227,94237,61832,65731,643
Other spending2,9333,1152,9683,2194,2783,9883,5354,318
Projects with external credits1,7942,1081,614869592456533565
Capital expenditure 2/19,44123,05619,30517,85517,14018,26319,38316,528
Reserve fund000000100107
Net lending and expense refunds−428−488−657−1,002−949−1,03600
Fiscal balance−33,621−23,710−14,774−15,772−12,493−10,361−21,432−22,234
Primary balance−26,941−15,545−4,343−5,206−2,451−1,532−11,152−10,531
Financing33,62123,71014,77415,77212,49310,36121,43222,234
External borrowing (net)14,80715,25019,27113,35112,591−3,8097,90710,415
Domestic borrowing (net)20,84112,3775,3058,9728,1947,69311,21411,769
Use of deposits−2,161−3,827−9,916−6,630−8,7459,0042,2610
Privatization proceeds2890525005050
Financial liabilities
Gross general-government debt 3/163,022191,423224,040247,499270,338280,173299,294321,477
Gross general-government debt excl. guarantees147,261179,639210,254232,766254,472264,032283,153305,337
External67,71785,382101,476114,997133,248132,597140,504150,919
Domestic79,54494,257108,778117,769121,224131,435142,650154,418
Memorandum item:
Gross general government debt (authorities definition) 4/194,459223,268240,843267,151295,656315,692
Sources: Ministry of Public Finance; Eurostat; and IMF staff estimates and projections.

Includes EU-financed capital projects.

Does not include all capital spending.

Total consolidated general-government debt, including state government debt, local government debt, and guarantees.

Includes guarantees and intra-governmental debt.

Sources: Ministry of Public Finance; Eurostat; and IMF staff estimates and projections.

Includes EU-financed capital projects.

Does not include all capital spending.

Total consolidated general-government debt, including state government debt, local government debt, and guarantees.

Includes guarantees and intra-governmental debt.

Table 5c.Romania: Consolidated Government Balance Sheet, 2010–14(In millions of lei, unless otherwise indicated)
20102011201220132014
Net worth and its changes:528,971495,709497,159526,277522,343
Nonfinancial assets570,521582,568597,894643,361665,417
Fixed assets556,739568,669583,573628,600648,510
Buildings and structures….….….….….
Machinery and equipment….….….….….
Other fixed assets….….….….….
Inventories13,78213,89914,32114,76116,907
Valuables….….….….….
Nonproduced assets….….….….….
Financial assets159,092153,768172,411174,871174,586
by instrument
Monetary gold and SDRs
Currency and deposits19,85019,65830,66437,01748,061
Securities other than shares
Loans6,3456,6336,6666,4036,463
Shares and other equity90,89181,65484,09175,28981,321
Insurance technical reserves
Financial derivatives
Other accounts receivable42,00545,82450,99049,84051,135
by debtor
Domestic….….….….….
Foreign….….….….….
Liabilities200,642240,628273,146291,956317,660
by instrument
Special Drawing Rights (SDRs)
Currency and deposits4,6776,3984,9874,2226,755
Securities other than shares84,731110,589145,165167,839202,936
Loans73,76381,52681,82980,85275,412
Shares and other equity7,9305,5832
Insurance technical reserves
Financial derivatives1,17769
Other accounts payable28,36536,46341,16339,04332,558
by debtor
Domestic101,216121,387137,791157,771
Foreign99,426119,240135,354132,958
Memorandum items
Net financial worth(41,550)(86,860)(100,735)(117,084)(143,074)
Maastricht debt159,617193,201222,797242,194265,709
Memorandum:
Nominal GDP (Lei - billions)533.9565.1595.4637.5667.6
Sources: Romanian authorities; Eurostat; and IMF staff calculations.
Sources: Romanian authorities; Eurostat; and IMF staff calculations.
Table 6.Romania: Monetary Survey, 2011–17(In millions of lei, unless otherwise indicated; end period)
2011201220132014201520162017
Prelim.Proj.Proj.
I. Banking System
Net foreign assets15,74030,20360,65994,282108,427123,306135,569
In millions of euros3,6446,82013,52521,03523,96427,28030,026
o/w commercial banks−21,846−18,594−15,953−11,778−9,849−7,903−7,004
Net domestic assets200,468191,815180,937167,549177,874190,194203,011
General government credit, net52,59649,59944,98539,19446,65852,13557,481
Private sector credit223,037225,836218,462211,164217,532226,376236,847
Other−75,165−83,620−82,510−82,809−86,317−88,317−91,317
Broad Money (M3)216,208222,018241,547261,831286,301313,500338,580
Money market instruments4,149188296258129142153
Intermediate money (M2)212,059221,830241,251261,573286,172313,358338,427
Narrow money (M1)85,83489,020100,311118,582149,602165,383173,787
Currency in circulation30,61031,47734,78539,89046,48251,68354,309
Overnight deposits55,22457,54365,52678,691103,120113,701119,478
II. National Bank of Romania
Net foreign assets110,106112,552132,202147,071152,988159,029167,193
In millions of euros25,48925,41429,47932,81333,81335,18337,031
Net domestic assets−48,541−55,244−63,537−78,694−78,998−71,985−75,726
General government credit, net−13,564−24,973−31,204−41,757−37,675−32,675−28,675
Credit to banks, net−19,529−14,443−23,266−24,064−27,465−32,075−39,641
Other−15,448−15,828−9,067−12,873−13,857−7,235−7,410
Reserve money61,56557,30868,66668,37773,99087,04491,467
(Annual percent change)
Broad money (M3)6.62.78.88.49.39.58.0
NFA contribution−1.76.713.713.95.45.23.9
NDA contribution8.3−4.0−4.9−5.53.94.34.1
Reserve money11.7−6.919.8−0.48.217.65.1
NFA contribution1.24.034.321.78.78.29.4
NDA contribution10.5−10.9−14.5−22.1−0.49.5−4.3
Domestic credit, real5.9−4.8−5.9−5.86.73.92.2
Private sector, real3.3−3.5−4.8−4.24.12.51.2
Public sector, real18.2−10.2−11.1−13.420.510.16.6
Broad money (M3), in real terms3.4−2.27.17.210.77.94.4
Private credit, nominal6.61.3−3.3−3.43.14.14.6
Memorandum items:
CPI inflation, eop3.15.01.60.8−0.91.53.4
NBR inflation target band2.0 - 4.02.0 - 4.01.5 - 3.51.5 - 3.51.5 - 3.51.5 - 3.51.5 - 3.5
Interest rates (percent) 1/
Policy interest rate6.05.254.002.751.751.75
Interbank offer rate, 1 week6.05.91.80.70.60.4
Corporate loans 2/9.79.86.85.94.34.3
Household time deposits 2/6.65.63.92.81.51.2
Share of foreign currency private deposits33.636.734.533.933.3
Share of foreign currency private loans63.462.560.956.349.3
Sources: National Bank of Romania; and IMF staff estimates and projections.

For policy and interbank rates: data as of April 2016; for loan and deposit rates: data as of February 2016.

Rates for new local currency denominated transactions.

Sources: National Bank of Romania; and IMF staff estimates and projections.

For policy and interbank rates: data as of April 2016; for loan and deposit rates: data as of February 2016.

Rates for new local currency denominated transactions.

Table 7.Romania: Financial Soundness Indicators, 2010–15(In percent)
201020112012201320142015
Dec.Dec.Dec.Dec.Dec.Dec.
Prel.
Core indicators
Capital adequacy
Capital to risk-weighted assets15.014.914.915.017.317.5
Tier 1 capital to risk-weighted assets (1/)14.213.913.813.714.315.1
Asset quality
Nonperforming loans (2/) to total gross loans11.914.318.221.913.913.6
IFRS Provisions for NPLs / NPLs76.767.869.857.4
Earnings and profitability
Return on assets−0.2−0.2−0.60.1−1.21.4
Return on equity (3/)−1.7−2.6−5.91.3−11.612.8
Net interest income to operating income60.662.062.358.558.357.8
Noninterest expense to operating income (cost to income)64.967.858.756.755.457.6
Personnel expense to operating income21.021.926.025.524.926.6
Liquidity
Liquid assets (4/) to total assets60.058.757.656.357.454.2
Liquid assets (4/) to short-term liabilities (5/)142.2151.8147.7156.4159.2163.7
Liquid assets (4/) to total attracted and borrowed sources80.975.876.473.574.157.0
Foreign exchange risk
Net open position in foreign exchange, in percent of capital−1.4−4.7−1.82.5−2.00.8
Lending in foreign exchange, in percent of non-gov. credit63.063.462.560.956.249.3
Foreign currency liabilities, in percent of total attracted and borrowed sources43.544.846.345.242.941.5
Deposits in foreign exchange, in percent of non-gov. dom. deposits36.033.536.434.133.232.4
Encouraged indicators
Deposit-taking institutions
Leverage ratio (6/)8.18.18.07.77.37.3
Personnel expenses to noninterest expenses32.332.344.344.945.046.2
Customer deposits to total (non-interbank) loans84.884.087.398.7109.5116.5
Loan-to-Deposit (LTD) Ratio117.9119.1114.5101.391.385.8
Structural indicators (November 2015)
Number of banks: 37; Number of foreign-owned subsidiaries/branches: 23/8; Share of deposits/loans of 5 largest banks: 58.2 percent/56.4 percent
Source: National Bank of Romania.

For 2008–10, market and operational risk are not used in compiling risk weighted assets.

In December 2015, the NBR moved from a national definition to an EBA methodology-based definition of NPL’s.

Return on equity is calculated as net profit/loss to average own capital.

Liquid assets = balance sheet assets and off balance sheets items with residual maturity of up to 3 months.

Short term liabilities = balance sheet liabilities and off balance sheet items with residual maturity of up to 3 months.

Tier 1 capital to average assets.

Source: National Bank of Romania.

For 2008–10, market and operational risk are not used in compiling risk weighted assets.

In December 2015, the NBR moved from a national definition to an EBA methodology-based definition of NPL’s.

Return on equity is calculated as net profit/loss to average own capital.

Liquid assets = balance sheet assets and off balance sheets items with residual maturity of up to 3 months.

Short term liabilities = balance sheet liabilities and off balance sheet items with residual maturity of up to 3 months.

Tier 1 capital to average assets.

Annex I. Implementation of the 2015 Article IV Key Recommendations
Key RecommendationsPolicy Actions
Fiscal
Maintain fiscal adjustment achievements and put public debt as a share of GDP on a downward path



Improve revenue administration





Improve public expenditure management including through higher EU funds absorption
2015 fiscal deficit lower than targeted and public debt as a share of GDP declined, but 2016 budget envisages a substantially higher deficit raising the public debt ratio.



Several administrative measures implemented that have strengthened tax collection (compared to a weak base though). Nonetheless, tax collection gap remains substantial.



Tighter scrutiny of the selection of domestically financed investment projects and higher EU funds absorption, though far less than envisaged. Limited progress toward better investment planning and execution.
Monetary and financial
Maintain easing bias and improve monetary policy framework





Continue intense watch on the banking and insurance sectors with a focus on better assessment of asset quality

Create effective insolvency frameworks





Reduce non-performing loans (NPL)
Policy eased throughout 2015. Interest rate corridor around policy rate narrowed, interventions in the foreign exchange market became more limited, and during last months of the year exchange rate became more flexible.



Implemented a balance sheet review of major insurance companies. Initiated process to conduct an asset quality review for major banks. Continued close bank supervision.



Personal insolvency law adopted but enforcement delayed by one year amid lack of development of effective secondary legislation and institutions. Continued efforts towards further NPL reduction and a sharp recent reduction in the NPL ratio.
Structural reforms
Further deregulate energy markets



Improve financial performance of state-owned enterprise (SOE) sector through better governance and restructuring



Increase private ownership in SOEs
Implemented the gas price deregulation for non-residential consumers. Continued implementation of electricity market deregulation.

Improvement in overall financial situation, albeit to varying degrees across the sector. Weak implementation of the SOE corporate governance law. Strengthened legislation prepared in line with IFIs recommendations still to be adopted.



Pursuit of majority privatization attempts of SOEs and initial public offerings unsuccessful.
Annex II. Romania: Risk Assessment Matrix (RAM) 1/
RiskRelative Likelihood and Transmission ChannelsExpected Impact if Risk is RealizedPolicy Response
MediumMedium
1. Tighter or more volatile global financial conditions
  • Investors may sell Romanian financial assets after reassessment of risks and increases in U.S. term premia.
  • Increase in borrowing costs
  • Risk of exchange rate overshooting and financial instability
  • Utilize some of fiscal financing buffer until markets settle down.
  • Allow for exchange rate flexibility while offsetting excessive market volatility
MediumMedium
2. A further deterioration in the fiscal balance above the targeted budget
  • Loss of recently built fiscal credibility and associated worsening of market sentiment
  • Romania enters EU’s Excessive Deficit Procedure and public debt rises.
  • Borrowing costs increase and private investment is crowded out weighing on growth prospects
  • Reverse tax cuts, restrain future wage increases, cut lower priority expenditure
  • Improve tax administration to raise more revenues
HighMedium
3. Persistent shortfall in public investment including through weak EU funds absorption
  • Bottlenecks in public administration continue to hamper public investment and EU funds absorption.
  • Delay in much-needed infrastructure upgrade would constrain growth prospects.
  • Improve EU projects implementation capacity
  • Improve investment prioritization, strengthen public investment review process, improve procurement framework
MediumMedium
4. Adoption of potentially harmful legislation for financial sector
  • Laws are adopted that contain retroactive and unilateral change of loan contracts.
  • Commercial banks incur substantial losses
  • Undermines future credit expansion and investor confidence by making the legal framework less predictable
  • Intervene by providing liquidity to solvent banks that come under financial stress
MediumMedium
5. Sharper-than-expected global growth slowdown
  • Exports could fall, particularly if the euro area enters into a protracted period of slower growth.
  • FDI could drop as investors reassess future euro area demand for Romanian exports.
  • Lower growth, higher unemployment
  • Potential widening of the current account deficit
  • Allow limited use of automatic stabilizers to work as a sharp fiscal deterioration could worsen market sentiment
  • Accelerate absorption of EU funds
  • Allow for exchange rate flexibility while offsetting excessive market volatility
HighLow/Medium
6. Persistently lower energy prices and low inflation in euro area
  • Low energy prices and imported euro area low inflation pass through to the overall price level.
  • Deflation lasts longer and inflation stays below target in the medium term.
  • Inflation expectations fall leading to their de-anchoring from inflation target.
  • Domestic demand gets a boost from higher real incomes and lower production costs.
  • Oil and gas producing companies cut investments, jobs and tax payments.
  • Ease monetary policy if deflationary pressures materialize
  • Strengthen policy communication to anchor inflation expectations.

The RAM shows events that could materially alter the baseline path. (The scenario most likely to materialize in the view of IMF staff.) The relative likelihood of risks is staff’s subjective assessment of risks surrounding the baseline. Non-mutually exclusive risks may interact and materialize jointly.

The RAM shows events that could materially alter the baseline path. (The scenario most likely to materialize in the view of IMF staff.) The relative likelihood of risks is staff’s subjective assessment of risks surrounding the baseline. Non-mutually exclusive risks may interact and materialize jointly.

Annex III. Debt Sustainability Analysis

Public debt in Romania is relatively low, but the recent partial reversal in fiscal adjustment exposes the fiscal position to risks. Under the baseline scenario, with deficit assumed to remain just below 3 percent of GDP, debt would moderately increase to reach slightly above 42 percent in 2021. However, the recent experience of Romania leading up to the 2008 crisis shows that a large pro-cyclical relaxation in fiscal balance could deteriorate substantially the debt dynamics. Moreover, the shock analysis shows that an adverse combination of macroeconomic shocks could bring the debt above the 60 percent threshold of the Stability and Growth Pact though below the 70 percent of GDP DSA benchmark. Finally, exchange rate volatility and exposure to international capital outflows are also risks, in consideration of the large share of foreign currency denominated debt and significant share of non-resident holders. Risks from known contingent liabilities are contained, since all outstanding guarantees are already included in public debt and banks are well capitalized and with limited exposure to short-term external debt. The external debt sustainability analysis indicates that the projected current account deficits remain sustainable.

Public Debt

1. The macroeconomic and fiscal assumptions underpinning the DSA are those of the medium-term baseline scenario. The output gap is expected to be slightly positive in 2016–18 and to be closed by 2021. Real growth would be close to 4 percent in 2016 and would stabilize at slightly above 3 percent afterwards. The fiscal balance is projected to deteriorate from 1.5 percent in 2015 to 2.8 percent (in cash terms; close to 3 percent in ESA terms) in 2016 and to remain close to 3 percent afterwards up until 2021. Under this scenario, Romania would not comply with the fiscal rules under the Fiscal Compact, but would conform to the 3 percent rule under the Stability and Growth Pact. Analysis of forecasts errors indicates that the size of the output contraction and of the fiscal deficit was underestimated during the crisis and the following slow recovery. More recently, growth projections were slightly pessimistic, while the forecast errors in the fiscal balance were broadly within the error band (interquartile range). Reflecting the deficit deterioration in 2016 and the projected flat path of the fiscal balance going forward, the three years average level of the cyclically adjusted primary balance in 2016 is slightly negative, while the maximum adjustment over a three-year horizon starting from 2016 is close to zero. Both are well below the 25 percentile benchmarks and suggest that baseline assumptions are realistic.

2. Public debt is relatively low, but the share in foreign currency is relatively high. Public debt, including guarantees, is estimated at 39.3 percent of GDP in 2015. It is projected to increase to about 42 percent by 2021. Gross financing needs are projected to remain rather stable at about 8 percent of GDP over the projection horizon. To manage some of the financing risk, the authorities maintain a foreign currency financing buffer (excluding privatization proceeds), which is about 3.3 percent of GDP or almost five months of gross financing needs. Most of longer-term debt is official financing while the average maturity of government securities issued on the domestic market is about three years. The authorities have been addressing rollover risks under their debt management strategy with a view to issuing longer-term securities as well as lengthening the yield curve. With foreign currency denominated debt accounting for about 55 percent of public debt, public debt is also exposed to exchange rate risk. Moreover, non-residents share in domestic debt securities holdings is about 20 percent.

3. Overall, public debt is sustainable but there is a risk it will rise above 60 percent under adverse scenarios. The stress test scenarios indicate that weaker GDP growth could push the debt ratio to 55 percent of GDP by 2021. A combination of adverse macro shocks could push the debt above 60 percent threshold of the Stability and Growth Pact by 2020. Barring unexpected events, potential contingent liabilities of the government would be limited. SOE debt is estimated at around 7.5 percent of GDP (including SOEs under insolvency procedures). Despite remaining vulnerabilities of the banking system, including due to a large share of foreign currency denominated loans and high rollover needs, downside risks are contained as banks are generally well capitalized and their short-term external liabilities are below 4 percent of GDP.

External Debt

4. The projected medium-term current account deficit of 3.5 percent of GDP is in line with a declining external debt-to-GDP ratio. The current account deficit adjusted remarkably since the global financial crisis, from 11.8 percent of GDP in 2008 to 1.1 percent of GDP in 2015, primarily on the back of strong exports (both goods and services) and import compression. However, the deficit is expected to widen gradually owing to increase in imports as the economy recovers. The current account deficit in the last two years was financed by a combination of private and public inflows. Going forward, FDI inflows are likely to steadily improve as the economy grows and will contribute partly towards financing the current account deficit. External debt has been on a downtrend since 2012 due to the decline in private external liabilities, partly reflecting deleveraging in the banking sector. Going forward, the external debt as a share of GDP is expected to rise in 2016 by 2 percentage points, mainly due to the increase in private debt, but then gradually fall from 2017.

5. The external debt sustainability analysis indicates that the projected current account deficits remain sustainable. Gross external debt, at 56.7 percent of GDP at end-2015, was 6.4 percentage points below 2014. The improvement was due to the fall in both public and private sector debt. Around one-third of the external debt stock was public debt. Almost one-fifth of external debt was at short-term maturities, mainly of the non-bank sector. Short-term financing risk for non-bank private sector is expected to be limited, as a substantial portion of the short-term debt is intra-company loans with relatively low rollover risks.

6. Romania could be vulnerable in the medium term if negative global market sentiment, induced by a broader emerging markets slowdown and/or oil price decline, leads to sharp currency depreciation. Bound tests indicate a 30 percent currency depreciation shock would substantially increase the external debt-to-GDP ratio over the medium term. However, other standard shocks would only lead to a slower decline in the external debt-to-GDP ratio.

Annex III. Figure 1.Romania: Public DSA Risk Assessment

Source: IMF staff.

1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white.

Lower and upper risk-assessment benchmarks are:

200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.

4/ EMBIG, an average over the last 3 months, 30-Dec-15 through 29-Mar-16.

5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.

Annex III. Figure 2.Romania Public DSA—Realism of Baseline Assumptions

Source: IMF Staff.

1/ Plotted distribution includes program countries, percentile rank refers to all countries.

2/ Projections made in the spring WEO vintage of the preceding year.

3/ Not applicable for Romania.

4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.

Annex III. Figure 3.Romania Public Sector Debt Sustainability Analysis (DSA)—Baseline Scenario

(In percent of GDP unless otherwise indicated)

Source: IMF staff.

1/ Public sector is defined as general government and includes public guarantees, defined as.

2/ Based on available data.

3/ EMBIG.

4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.

5/ Derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

6/ The real interest rate contribution is derived from the numerator in footnote 5 as r - π (1+g) and the real growth contribution as -g.

7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).

8/ Includes changes in the stock of guarantees, asset changes, and interest revenues (if any). For projections, includes exchange rate changes during the projection period.

9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Annex III. Figure 4.Romania Public DSA—Composition of Public Debt and Alternative Scenarios

Source: IMF staff.

Annex III. Figure 5.Romania Public DSA—Stress Tests

Source: IMF staff.

Annex III. Figure 6.Romania: External Debt Sustainability: Bound Tests1/2/

(External debt in percent of GDP)
(External debt in percent of GDP)

Sources: International Monetary Fund, Country desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2013.

Annex III. Table 1.Romania: External Debt Sustainability Framework, 2011–21(In percent of GDP, unless otherwise indicated)
ActualEst.Projections
20112012201320142015201620172018201920202021Debt-stabilizing
non-interest
current account 6/
Baseline: External debt74.074.668.063.156.758.756.652.748.945.642.4−2.8
Change in external debt1.10.6−6.6−4.9−6.42.0−2.1−3.9−3.8−3.3−3.2
Identified external debt-creating flows (4+8+9)0.02.6−6.4−4.0−4.5−2.2−1.3−0.8−0.40.10.3
Current account deficit, excluding interest payments2.22.3−1.6−1.6−0.6−1.00.50.81.31.82.0
Deficit in balance of goods and services5.85.10.80.30.51.72.42.52.73.03.1
Exports36.637.339.741.241.139.139.640.340.841.541.9
Imports42.442.340.541.541.640.842.042.843.544.445.0
Net non-debt creating capital inflows (negative)−1.4−2.1−1.9−1.7−1.6−1.7−1.8−1.8−1.8−1.8−1.8
Automatic debt dynamics 1/−0.92.3−2.9−0.7−2.30.40.00.10.10.10.1
Contribution from nominal interest rate2.72.52.62.01.72.72.01.91.71.61.5
Contribution from real GDP growth−0.7−0.5−2.4−1.9−2.2−2.3−2.0−1.7−1.6−1.5−1.4
Contribution from price and exchange rate changes 2/−2.80.3−3.1−0.8−1.8
Residual, incl. change in gross foreign assets (2-3) 3/1.2−2.0−0.2−1.0−1.94.3−0.9−3.1−3.4−3.4−3.5
External debt-to-exports ratio (in percent)202.3200.2171.1153.0137.9150.1143.0130.8119.8110.0101.1
Gross external financing need (in billions of Euros) 4/38.945.245.641.642.042.541.744.044.545.143.8
in percent of GDP29.233.931.627.726.225.423.523.322.321.419.6
Scenario with key variables at their historical averages 5/58.757.554.350.747.243.7−4.8
10-Year10-Year
HistoricalStandard
Key Macroeconomic Assumptions Underlying BaselineAverageDeviation
Real GDP growth (in percent)1.10.63.53.03.82.74.74.23.63.33.33.33.3
GDP deflator in Euros (change in percent)4.0−0.44.31.12.94.77.80.22.42.82.42.52.6
Nominal external interest rate (in percent)3.93.33.83.12.94.11.05.03.63.53.53.53.5
Growth of exports (Euro terms, in percent)20.32.015.18.06.413.813.6−0.67.38.07.27.57.1
Growth of imports (Euro terms, in percent)16.10.13.36.87.010.818.42.39.28.17.78.07.3
Current account balance, excluding interest payments−2.2−2.31.61.60.6−3.64.81.0−0.5−0.8−1.3−1.8−2.0
Net non-debt creating capital inflows1.42.11.91.71.63.42.61.71.81.81.81.81.8

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in Euro terms, g = real GDP growth rate, e = nominal appreciation (increase in Euro value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; Euro deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, Euro deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in Euro terms, g = real GDP growth rate, e = nominal appreciation (increase in Euro value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; Euro deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, Euro deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Annex IV. External Sector Assessment

Staff’s overall assessment is Romania’s external position in 2015 was broadly in line with fundamentals.

1. Foreign Assets and Liabilities. Romania’s net international investment position (IIP), as a share of GDP, has improved since 2012. The IIP was -50.2 percent of GDP in 2015, a 6.7 percentage points improvement since 2014 due to the decrease in foreign liabilities. Going forward, the IIP is expected to continue to improve due to mainly the continued reduction in external liabilities.

Romania: Estimated Policy Contributions to Current Account Gap, 2015(percent of GDP)
EBA-Lite CA Method
Cyclically-adjusted CA−1.0
Cyclically-adjusted CA (removing temporary factors)−2.0
Cyclically-adjusted CA norm−3.0
Model estimated CA gap2.0
Of which:
World fiscal deficits0.7
Domestic fiscal deficits−0.2
Policy gaps, other0.4
Residuals1.2
Adjusted CA gap (removing temporary factors)1.0
EBA-Lite REER Index Model
REER Gap 1/−2.0
EBA-Lite External Sustainability Model
CA Gap0.9
REER Gap 1/−3.6

Negative value implies REER is below levels consistent with fundamentals and desirable policies.

Negative value implies REER is below levels consistent with fundamentals and desirable policies.

2. Current Account. Romania’s current account deficit has narrowed remarkably since the global financial crisis, from 11.8 percent of GDP in 2008 to 1.1 percent in 2015, primarily on the back of strong exports (both goods and services) and import compression. Exports of goods and services comprise around 40 percent of GDP (compared to the pre-crisis level of 25 percent of GDP). The current account deficit has modestly deteriorated last year, primarily due to the increase in goods deficit and the almost doubling of primary income deficit. The Fund’s recently developed EBA-lite tool1 estimates that a cyclically-adjusted CA norm of -3.0 percent of GDP is consistent with medium-term fundamentals. The estimated CA gap of 2.0 percent includes policy gap of 0.9 percent, mainly due to the fiscal gap in the rest of the world. The EBA-lite model does not completely capture the temporary factors responsible for the sharp adjustment of the current account in Romania since 2007. The large compression in imports and the strong exports since 2007 is likely to be partly temporary and reverse to some extent, and the current account deficit is expected to gradually widen to 3.5 percent in the medium term. Hence, staff assesses that the cyclically-adjusted CA, removing all temporary factors predominantly related to imports, would be around -2 percent of GDP, implying that the underlying cyclically-adjusted current account deficit is lower than the cyclically-adjusted norm.2

Gross international reserves vs. traditional metrics

(in billion US$)

Sources: World Economic Outlook, International Financial Statistics; and Fund staff calculations.

3. Real Exchange Rate. The real exchange rate has depreciated by around 4 percent in 2015. Assuming that exchange rate changes would be the primary driver for a current account adjustment, the EBA-Lite CA model estimates that an appreciation of around 8 percent would be needed to close the gap between the underlying cyclically-adjusted current account and the norm. However, staff assessment, incorporating the temporary factors in the current level of the cyclically-adjusted current account, implies that an appreciation of around 4 percent of the currency would be required to close the CA gap. The EBA-Lite REER index model suggests a modest undervaluation of 2 percent, while the EBA-Lite External Sustainability Approach suggests an undervaluation of around 3.6 percent. Overall, staff assesses that the real exchange rate is broadly in line with its equilibrium level. However, caution is needed to ensure that the recent wage pressure, an average increase of 8 percent in 2015, due to the rise in public wages and minimum wages do not undermine competitiveness.

4. Reserve Adequacy. Reserve coverage in Romania is broadly adequate according to most reserve adequacy metrics. The reserve level of €35.5 billion at end-December 2015 was above the level recommended by the standard rules of thumb (three months coverage of prospective imports and 20 percent of broad money). It was also in line with the new reserve adequacy metric for emerging markets developed by Fund staff. Reserves fell slightly short of the 100 percent short-term debt (at remaining maturity) benchmark, but this metric has improved recently due to the reduction in short-term external liabilities. Nevertheless, in light of continued downside external risks, a prudent stance with moderate reserve accumulation remains appropriate.

Annex V. Fiscal Institutions

1. Romania’s national and sub-national fiscal rules follow the EU model. In 2013, the 2010 Fiscal Responsibility Law (FRL) was amended in line with EU requirements to include structural fiscal targets and specify corrective actions in case of deviations. Currently, the MTO for Romania is 1 percent of GDP deficit, to be achieved through structural annual adjustments of 0.5 percent of GDP. Also following EC provisions, the annual increase of expenditures should not exceed the projected nominal GDP growth for the next three years until the budget balance is in surplus. Public debt should not exceed 60 percent of GDP. Municipalities’ budgets, excluding loans to finance investment and debt refinancing, have to be balanced. Municipalities cannot contract or guarantee loans if their annual public debt service (principal payment, interest, and commissions) including the loan they want to contract, is higher than 30 percent of their own revenue.

2. A Fiscal Council was established in mid-2010. This was one of the main objectives of the 2010 FRL. The council issues opinions and recommendations on official macroeconomic and budgetary forecasts, the annual budget laws, and assesses the compliance of the medium-term fiscal strategy with the principles and rules specified in the FRL.

Source: European Comission Fiscal Rules Database.

3. On paper, Romania’s fiscal rules fare well in comparison with the rest of the EU. The EC periodically assesses the quality of European countries’ fiscal rules. The last available assessment was done in 2014 and it is organized around five main indicators for both the local and the general governments (figure): (i) the legal basis of the rule (such as constitution or law); (ii) the room for revising the objectives; (iii) the institutions in charge of enforcement, monitoring and alerting (such as independent authority or the parliament); (iv) the enforcement mechanisms (such as an automatic sanction mechanism in case of non-compliance); and (v) media visibility (triggering public debate). Based on these indicators, the general government rules fare well on the whole. At the local level, enforcement mechanisms and media visibility are area with margins for improvement.

4. However, the actual enforcement of the rules is weak. The fiscal rules have been repeatedly circumvented in the recent past. A recent example of non-compliance relates to the 2016 budget law that breaches the fiscal rule but contained specific provisions to waive the FRL (in this way also avoiding triggering the automatic sanctions foreseen by the FRL). The effectiveness of the rules should be strengthened through increasing the public awareness of the rules, ensuring proper tracking of risk of breaching them, and strengthening automatic sanctions to incentivize responsible parties to apply the rules.

Annex VI. Inflation Outlook in Romania

1. Headline inflation has come down markedly in Romania over recent years. Romania experienced elevated levels of inflation in early 2000s which it was able to bring down on account of the increasingly successful stabilization of the economy and the improving structural factors, including successful wage policies, and relying on exchange rate as a nominal anchor to contain depreciation. Direct inflation targeting was introduced in August 2005 and since then inflation has been close to, though mostly slightly above, the target range. In the very recent period, headline inflation has declined in Romania in line with regional peers; it fell below the target in 2014 before entering the negative territory in June 2015.

Regional Inflation Developments

(percent)

Sources: IMF World Economic Outlook.

1/ Peer countries include BGR, CZE, EST, HRV, HUN, LTA, LTU, POL, and SVK.

Headline Inflation—Contributions by Components

(percent, annual inflation)

1/ Harmonized Index of Consumer Prices (HICP).

2/ HICP at constant tax rates.

Sources: Eurostat; and IMF staff calculations.

2. Key factors behind the fall in inflation were oil and food price developments, but especially the recent reduction in the VAT rate. Three episodes of a noticeable fall in inflation can be identified. The first in mid-2013 was largely due to lower food prices following an abundant harvest and a reduction in VAT on some food products. The second episode, since autumn 2014, was mainly the result of declining international energy prices. And most recently, the key reasons why the inflation rate turned negative were the VAT rate reduction on food items from 24 to 9 percent in mid-2015 and the standard VAT rate reduction from 24 to 20 percent in January 2016.

3. Despite the fall in headline inflation, underlying inflation is positive, and inflation expectations are close to target. Headline inflation in the first half of this year is expected to fall lower, following the recent standard VAT rate reduction (from 24 to 20 percent), lower import prices, and the decrease of tariffs for electricity. Underlying inflation—adjusted for the VAT cut but nevertheless incorporating lower international food and energy prices—has been rising in recent months and reached 2.3 percent in December 2015 (HICP at constant tax, Eurostat estimate). Based on the latest projections by the NBR, underlying inflation is projected to reach 3.7 percent by end-2017. So far, consensus forecasts for 2017 and 2018 have stayed close to the target.

Output Gap, Wage Growth, and Fiscal Impulse1/

(percent)

Source: IMF staff calculations.

1/ Measured as the annual change in the primary structural general government fiscal deficit.

4. Going forward, a number of domestic factors point to a potential buildup of inflationary pressure that should be carefully monitored. The output gap is projected to turn positive this year, as the Romanian economic growth is set to accelerate; wage pressure is growing, following the announced, large-scale upward adjustment in minimum wages and public wages; moreover, the fiscal impulse of about 2 percent of GDP is likely to drive up inflation expectations. Besides the pressures from demand factors, inflation is expected to rise as a number of supply shocks would likely reverse or phase out over the next 12 months.

Annex VII. Minimum Wage Policy in Romania

1. Minimum wage policy in Romania has been increasingly active in recent years. Minimum wages will be raised in May 2016, resulting in about 78.6 percent increase compared to end-2012. Minimum wage in Romania also showed the sharpest rise among EU countries, although the increase could partly indicate the progressive convergence with peers. With the planned increase in 2016, the minimum wage in Romania would leap to approximately 45.3 percent of mean wage and 65.4 percent of median wage which is high by international standards. In 2013, there were approximately 430,000 workers in Romania with wages at or below the minimum wage, accounting for about 11.2 percent of total workers registered. Minimum wage workers are largely concentrated in construction, trade, manufacturing, hotels and restaurants. The majority of these workers are among working-age group and about two-thirds of minimum wage workers are male. There was only 0.5 percent of government employees who received minimum wage in 2013, and a large increase in public sector wage in 2016 would lift the monthly salary for all government employees above the minimum wage.

2. The increase in minimum wage is aimed at reducing poverty. The Romanian government introduced the active minimum wage policy as part of measures to tackle poverty as committed in the Europe strategy 2020. A rise in minimum wage would reduce the number of low-paid workers—the share of workers at or below the minimum wage rose to 11.3 percent after the first hike in 2013, from around 4 percent in 2012. However, minimum wage is a poorly targeted instrument and may not be effective in reducing poverty as the effects would depend largely on the extent to which the population of minimum wage earners and that of the working poor are overlapped (IMF Country Report No. 14/221 and OCED (2015)).

3. Sharp increases in minimum wage may nevertheless have undesirable economic effects. Several studies find that high minimum wage to gross average wage ratio could undermine external competitiveness and export performance, while hampering potential foreign direct investment that could benefit low-skilled labor. Minimum wage is, in principle, a wage floor. If the floor is set too high, it could affect firms’ profitability and discourage employers from hiring. Studies generally find negative labor demand elasticity to the change in minimum wage, particularly among young or low-skilled workers. But, the net effect on the total employment may be varied, depending on the overall economic conditions and labor market structures across countries. Sharp and sudden minimum wage increases are more often associated with sizeable employment effects, particularly if the initial level of minimum to average wage ratio is already at high level.

4. Future decisions on minimum wage need to be carefully crafted. The International Labor Organization (ILO) Convention on Minimum Wage Fixing (1970) suggests several elements to be taken into consideration in determining the level of minimum wages: (a) the needs of workers and their families and (b) economic factors including the requirements of economic development, levels of productivity and the desirability of attaining and maintaining a high level of employment. Minimum wage in Romania is determined at the national level by the government after consulting trade unions and employers’ organizations. As minimum-to-average wage ratios in Romania are already higher than its peers, the economic effects could weigh on Romania’s perceived competitiveness in the region. Hence, future minimum wage adjustments could usefully be based on a transparent and clear mechanism and avoid unsustainably rapid increases to avoid adverse effects. Finally, periodic assessments of the impact of labor market policy including minimum wages by labor market expert committees could usefully inform future policy decisions.

1The new tax code involves a welcome simplification of taxation legislation and has some small measures with positive revenue effects, including base broadening of social security contributions.
2The budget deterioration related to the new tax code and the public wages increases is estimated at about 2.4 percent of GDP in 2016 and 0.8 percent in 2017 as shown in the text table. The increase in the 2016 deficit over 2015 is less than 2.4 percent of GDP mainly because the 2015 deficit incorporated about 1.1 percent of GDP of temporary deficit-increasing factors that will not occur in 2016 and 2017.
3Recent public wage increases have exacerbated distortions in the remuneration system. Staff has recommended in the past to eliminate these distortions through adopting and gradually implementing a unified wage law in line with available fiscal space.
4See Selected Issues Paper for a detailed discussion on financial sector developments and macro-financial linkages in Romania.
1The External Assessment (EBA) methodology has been developed by IMF as a successor to the former CGER exercise. There are two important differences. First, EBA makes a sharper distinction between positive (descriptive) understanding of current accounts and real exchange rates and making normative evaluations. Second, EBA takes into account a much broader set of factors—including policies, cyclical conditions, and global capital market conditions—that may influence the current account and real exchange rate. For more details, see “The External Balance Assessment (EBA) Methodology,” IMF Working Paper, WP/13/272. EBA-Lite model has been developed using the same methodology for countries not included in EBA. For more details, see “Methodological Note on EBA-Lite” at http://www.imf.org/external/pp/longres.aspx?id=5017.
2The EBA-lite model includes two variables to capture temporary components of the CA (the output gap and temporary terms of trade changes), but in some instances these may not capture other temporary phenomena. The contraction in investment/imports during and after crises is generally much larger than what can be explained by linear specifications for the output gaps.

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