The macroeconomic fundamentals of Romania grew significantly stronger after the global crisis. Economic growth consolidated and has lately accelerated while unemployment dropped significantly. Inflation has eventually returned to positive values and is slowly but steadily advancing towards the central bank’s target. Fiscal and current account deficits bottomed out in 2014-2015 and remain at relatively moderate levels after the ongoing fiscal relaxation which started in 2015. The current account deficit and external debt remain sustainable. The banking system is sound, NPL ratios decreased significantly, adequate buffers are in place and no public funds have been used to support the banking sector during or after the global financial crisis. While some vulnerabilities persist, high risks to financial stability from legal initiatives have abated. Maintaining the fiscal deficit on target appears to be somewhat challenging, but authorities are fully committed to act proactively and take the necessary steps to contain the risks. Fiscal stimulus complemented by improved EU funds absorption and deep structural reforms could unlock more sustainable and inclusive growth.
The Ex-Post Evaluation of Exceptional Access Under the precautionary 2013 SBA provides a useful assessment of the program including valuable lessons that can be used to improve the Fund’s products. The Romanian authorities appreciate the support received from the Fund in partnership with the European Commission and the World Bank. They broadly agree with the conclusions of the report.
Growth accelerates under stimulus measures while external position remains sustainable.
After three years of growth rates above 3 percent, the economic activity in Romania continued to gain momentum in 2016. The annual growth accelerated to 4.8 percent, the country’s highest after the crisis and one of the fastest in EU, while the average annual unemployment rate dropped to 5.9 percent, the lowest level in eight years. The expansion was primarily driven by private consumption, pushed to a nine-year high of 7.3 percent by stimulus from fiscal and income policies. Additional envisaged stimulus measures, the manifest recovery of the consumer confidence to the pre-crisis level, and the upward trend in consumer credit are expected to support further expansion of consumption, albeit at a slowing pace over the medium term. The dynamics of investment underwent a temporary setback in 2016, when the contribution of gross fixed capital formation to GDP growth turned negative. Nevertheless, investment growth is expected to resume in 2017 and gradually accelerate over the medium term, driven by credit expansion gaining momentum, accruing effects of growth-friendly tax cuts, and steady improvement of the EU funds absorption. Factoring in significant second-round effects of multiple fiscal stimuli on both domestic demand and potential output, the government projects faster growth than staff’s baseline: one percentage point higher in 2017 and a moderately accelerating (rather than Fund’s decelerating) path over the medium term.
At the beginning of 2017 the annual CPI inflation rate raised above zero after successive VAT cuts and other disinflationary supply shocks held it at negative values since June 2015.
Dwindling influence of these factors along with a positive output gap will drive inflation upwards, allowing it to reenter the ±1 percentage point variation band of the 2.5 percent flat target by end-2017. Thereafter, in the absence of unanticipated shocks, the inflation rate is expected to remain within the target band.
The current account deficit widened in 2016 by 1.1 percent of GDP on the back of imports boosted by buoyant consumption and a higher deficit in the primary income balance. However, the current account deficit was fully matched by the net FDI inflows which recorded a significant increase in 2016, driven mainly by reinvested earnings and intra-company loans. The deficit is anticipated to remain at sustainable levels over the medium term, with exports growth fueled by the gradual recovery of the external demand from EU main trading partners. Since the external deficit financing is expected to come mainly from non-debt-generating flows - FDI and EU funds -, the downward trend of the external debt-to-GDP ratio is projected to continue in the medium term. Both staff and the authorities agree that the external position in 2016 has been broadly in line with the fundamentals; recent developments continue to warrant this assessment. The share of short-term debt in total external debt is relatively low (around 25 percent), and the international reserves coverage is adequate according to all reserve adequacy metrics. Notwithstanding good fundamentals, the external position may be vulnerable to a sharp depreciation of the domestic currency triggered by a sudden worsening of the market sentiment. The authorities carefully monitor these risks.
While fiscal relaxation will be maintained in the short run, budget deficits will be kept within the limits allowed by EU fiscal rules.
In line with the government strategy of promoting economic growth, the fiscal relaxation initiated in previous years has continued at the beginning of 2017, through measures aimed at both increasing the real disposable income of households and improving business environment and supply incentives. The medium term strategy foresees the ESA budget deficit being held constant at slightly below the limit of 3 percent of GDP in 2017-2018, followed by a fiscal consolidation to 2 percent by 2020. While acknowledging the challenge of meeting the 2017-2018 targets, the authorities are strongly committed to comply with the EU fiscal rules, by closely monitoring the budget execution and taking compensatory measures if necessary. To mitigate the risks associated with the fiscal impact of the unified wage law, the authorities will adopt a gradual and flexible implementation which will take fiscal space constraints into consideration.
Concrete measures and reforms to increase budget revenues and reduce public spending, already taken or planned for 2017-2018, are identified in the April 2017 Convergence Report of Romania to the European Commission. An important measure designed to increase the VAT collection is the implementation as of July 1, 2017 of an anti-fraud system of split VAT payments which requires public institutions and enterprises to pay any VAT due for goods or services directly to the State budget account rather than to the supplier. Among the programmed reforms aimed at enhancing expenditure efficiency are included: reducing the number of agencies and institutions subordinated to the government, rationalizing public spending based on principles of auditing, digitization, prioritization and performance assessment, improving corporate governance of SOEs, centralizing public procurement, creating a national database for records of public administration employment.
Monetary policy is focused on bringing inflation to target in the medium term.
Throughout 2016 and the beginning of 2017 the central bank kept unchanged both the monetary policy rate, at the historical low of 1.75 percent, and the amplitude of the symmetrical corridor of interest rates on standing facilities around the policy rate, at ±1.50 percentage points. The status-quo approach was warranted by the persistent divergence between short-term developments in inflation and its longer-term outlook, as reflected by the central bank’s successive forecast updates over a period marked by high uncertainty and risks generated by both external and internal factors.
With persistent excess liquidity in the banking system, the central bank pursued an adequate management of money market liquidity and maintained the required reserve ratio on leu-denominated liabilities of credit institutions at 8 percent. However, given the ongoing contraction in foreign currency credit and consolidation of forex reserves, the NBR cut the required reserve ratio on forex-denominated liabilities twice (most recently on May 5, 2017) down to 8 percent, thus continuing the harmonisation of the reserve requirements mechanism with ECB standards and practices.
To increase transparency and the effectiveness of conveying to the markets the rationale behind the adopted decisions, the central bank started in September 2016 to publish the minutes of the NBR Board monetary policy meetings.
The central bank will continue to gear monetary policy towards bringing, and maintaining in the medium run, the annual inflation rate into line with the flat target, in a manner supportive of sustainable economic growth. However, the NBR Board emphasizes that a balanced macroeconomic policy mix and progress in structural reforms are crucial for macroeconomic stability and for the resilience of the Romanian economy to adverse global developments.
Financial stability continues to be robust and immediate risks from legal initiatives have been alleviated.
Romania is among the 5 EU members which haven’t used public funds to support the financial sector since the onset of the global crisis. The capital ratio of the Romanian banking sector is adequate and provides, together with the IFRS provisions, a consistent buffer to absorb potential losses and to support the lending activity. The average total capital ratio (18.3% as at December 2016) situates the Romanian banking sector in the lowest European Banking Authority’s risk bucket. Contagion risks continue to decline with banks increasingly substituting domestic deposits for foreign sources of funding and the total share of domestic currency loans on the rise for five years.
NPLs have fallen significantly due to the NBR’s efforts to encourage banks to clean-up their balance sheets. The overall NPL ratio dropped from 21.5 percent in September 2014 to less than 10 percent presently. Further efforts are needed, since NPL ratios for corporates and SMEs are still high. However, the NPLs are well provisioned, the EBA Risk Dashboard lists Romania’s coverage ratio the highest in EU as of Q4 2016.
Liquidity is abundant and banks’ profitability improved in 2016, ROA (1.1 percent) and ROE (10.7 percent) standing at year end above EU averages. Credit to households advanced rapidly in 2016. Credit to non-financial corporations (NFCs) remained subdued throughout 2016, but has recently shown signs of recovery, amid stronger economic growth, improved confidence, and historically low interest rates.
The high risks for financial stability generated by two laws passed last year by the Parliament have abated following recent rulings by the Constitutional Court. One of the laws allows debtors to walk away from mortgages (“give-in-payment”); the Court’s ruling that the law should be applied on a case-by-case basis and within the provisions dealing with distressed borrowers in the civil code, has greatly limited the potential negative impact of this law on the banking sector. The second law, allowing debtors to convert Swiss Franc denominated loans into domestic currency loans at historical exchange rates, has been declared unconstitutional. However, authorities recognize that important risks to financial stability remain and need to be closely monitored. Highly significant is the risk of abrupt worsening of investor sentiment towards emerging economies, generated by uncertainties surrounding global economic growth, geopolitical tensions and Brexit implications for the future of the EU. Medium-term risks from rising banks’ exposure to households and government debt are also relevant. To help prevent and manage risks to financial stability, the authorities have set up a formal macroprudential authority, the National Committee for Macroprudential Supervision (NCMS). NCMS brings together representatives from the NBR, the financial supervisory authority and the government to formulate and coordinate macroprudential policies, issue warnings and recommendations (“soft laws”) for NBR and the financial supervisory authority. The authorities also welcome the forthcoming FSAP programmed for 2017-2018.
Improved EU absorption will support structural reforms critical for sustainable growth.
Significantly improving the EU funds absorption as a critical source of financing investment is a top priority for the authorities. While the absorption during the first years of the 2014-2020 financial framework has been weak, progress has been made with respect to designating the managing authorities, compliance with ex-ante conditionality, and limiting domestic financing of projects eligible for EU funding. The authorities are confident that further building on this base will allow a significant acceleration of the absorption in the coming years.
Steps have been taken to restructure major energy producers and prepare IPOs for some of them. SOEs reform is expected to gain momentum after the establishment of the Sovereign Fund for Development and Investment, envisaged to be launched in July 2017.
To stimulate labor mobility across the country and thus increase employment, the government instituted a system of grants for hiring, settlement and relocation. Measures have been taken to increase the quality of education -including through significant salary increases for educators- and to promote vocational training.
The authorities thank staff for the thorough and constructive discussions during and after the Article IV mission, and for their valuable advice on macroeconomic policies.