This Selected Issues paper analyzes the developments and determinants of inflation in Romania, and reviews the salient trends in public finance. The study describes the monetary policy issues and the improvements required to clean up the financial sector. The paper chronicles the balance-of-payments crisis in 1999, the external viability trends, reviews the economic and financial implications, and assesses Romania's compliance with EU economic criteria. The paper also provides a statistical appendix for the country.


This Selected Issues paper analyzes the developments and determinants of inflation in Romania, and reviews the salient trends in public finance. The study describes the monetary policy issues and the improvements required to clean up the financial sector. The paper chronicles the balance-of-payments crisis in 1999, the external viability trends, reviews the economic and financial implications, and assesses Romania's compliance with EU economic criteria. The paper also provides a statistical appendix for the country.


A. Introduction

1. The historic decision adopted by EU member countries at their Helsinki meeting in December 1999 to include Romania in the group of countries that are EU accession candidates signifies that Romania has moved to a new stage of its European integration process.2 The accession process provides an important impetus for the acceleration of much-needed reforms in Romania. Admittedly, with or without EU membership, most of the EU membership requirements (market liberalization and increased competitiveness) are necessary for long-term growth—but the EU accession process brings further opportunities as well as greater challenges to Romania and the other candidate countries. Eventual EU membership should improve long-term development prospects by providing access to a large single market and allowing free movement of goods, services, capital and people within the market. In the context of Romania’s candidacy for EU membership, this chapter (a) briefly reviews the economic and financial implications, and (b) assesses Romania’s compliance with EU economic criteria.3

2. The economics of EU accession is predicated on the assumption that incomes and living standards should converge toward EU standards. Economic integration is to be facilitated by bringing new opportunities for trade, and, as the economic environment becomes more attractive, by increasing foreign direct investment inflows. To this end, the “Europe Agreement” with the European Union provides Romania with easier access to EU markets, while the use of nonreimbursable resources provided by the EU (through the pre-accession instruments) would support investment-based growth. Harmonization of policies and regulations toward the acquis communautaire will in parallel gradually facilitate the circulation of goods, services, capital, and labor, and the entry into the single market.4

3. In aiming at converging to the EU’s living standards, Romania faces a daunting task. Closing the income gap with the EU will require that Romania raise its real GDP growth to rates that it has never attained so far. On a per capita basis, Romania has the second lowest income level after Bulgaria among the candidate countries. Moreover, the level of the population below the standard poverty lines is by far the highest in Romania (Table VI.1). Tang (2000) notes that, assuming an average real growth rate of 5 perzcent per annum and an EU average growth rate of 2 percent per annum, it would take 45 years to close the gap. Romania would need to grow annually by 7 percent to catch up with the EU in 2025.5

Table VI.1.

Differences in GDP Per Capita and Poverty Lines in Central and Eastern European Countries

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Source: World Bank Development Indicators 2000

1998 GDP per capita at PPP

In percent

4. The European Commission has specified the following prerequisites before Romania can pave a solid way to EU accession. First, macroeconomic stability, without which there cannot be sustainable growth, is essential.6 The transition experiences in neighboring Central European countries clearly show that a recovery in growth was achieved only after the economy had been stabilized and inflation had been brought down substantially.7 With an economic growth rate since 1990 among the lowest in the group of candidate countries, and an inflation rate among the highest, Romania is lagging behind, thereby undermining its chances of acceding to the Union at the same time as more advanced candidates.8 Second, the reform effort in structural areas must be pursued, as a means of enhancing economic efficiency and supporting the stabilization effort.9 Third, there is a need for a broad national consensus on economic policies in support of EU accession (see Box VI.1).

5. As elaborated in the remainder of this chapter, the EU’s invitation to accession negotiations entails (a) access to sizable external resources through pre-accession instruments; and (b) requirements on economic policies, with a view to ensuring nominal and real convergence.

B. The Impact of EU Transfers on the Romanian Economy

A privileged share of EU pre-accession aid

6. In order to help candidate countries meet the accession criteria, the EU has set up three types of pre-accession aid instruments (see Box VI.2). In addition to the existing PHARE programs, two other grant instruments have been established: SAPARD (Structural Adhesion Program for Agriculture and Rural Development) and ISPA (Pre-Adhesion Structural Instrument). Within the framework of the Agenda 2000 (the budgetary envelope allocated by the European Union to the Commission over the period 2000-2006), total disbursements on these instruments are foreseen to amount to €10.5 billion. In a full year, provided that all projected tranches funded through the pre-accession instruments are disbursed, the amount of transfers from the EU to Romania would reach €630 million, or about 2 percent of GDP. It would represent, in 2000,6 percent of government primary spending under the budget, and 25 percent of investment expenditure. By comparison, total EU assistance to the country during 1990-99, amounted to €1.2 billion (Figure VI.1). Of the 10 candidate countries from central and eastern Europe eligible for support under these three financing instruments, Romania ranks second after Poland in terms of volume of annual budgeted allocation, second after Bulgaria on a GDP comparison and fifth, after the Baltic States and Bulgaria, on a per capita comparison (Table VI.2).

National Consensus Vis-à-Vis a Market Economy and European Integration

In Romania, policy formulation and implementation has been undermined by disagreements within, and by the fragility of, the multi-party governing coalitions. In the wake of the European Council’s decision in Helsinki, Romanian political parties initiated a dialogue from which emerged a broad consensus about the essentials of economic policy over the medium term. More generally, representatives of the civil society expressed their willingness to undertake the necessary policies to meet the economic criteria set for EU accession, including the full acceptance of the principles of a market economy.

In March 2000, the main political parties, in association with the trade unions, employers’ associations and other representatives of the civil society (including churches), elaborated Romania’s Medium-Term Economic Strategy (MTES), which called for the creation of a “smooth-functioning market economy compatible with EU principles, norms, mechanisms, institutions and policies,” together with a macroeconomic scenario underlying the economic strategy. Four broad intermediate objectives were identified: (1) the clarification of ownership rights; (2) the adoption of the missing economic regulations to fill existing legal gap and inconsistencies; (3) the improvement in financial discipline; and (4) the reduction of the informal sector. The document was fleshed out in May 2000 by an Action Plan adopted by the Government in order to ensure implementation of the MTES. The Action Plan lists economic and structural measures that the government intends to undertake in the period 2000-2004. The Commission considered that “the sustained implementation of the MTES and the Action Plan would allow Romania to not only improve the living standards of the Romanian population but also to improve its chances of meeting the Copenhagen criteria for accession to the EU.” In addition, the National Programme for Accession to the European Union updated every year, is to ensure the continuation of the process of building up a functional market economy. The European Commission adopted formally a communication on Romania’s MTES on July 19, 2000 through a communication to the Council; the Action Plan was valued as it addresses “the pressing issues of economic reform in a constructive and realistic manner and is coherent with other international commitments in the area of economic policies, in particular the International Monetary Fund’s stand-by arrangement and the World Bank’s Structural Adjustment Loans”. The Commission mentioned that it would closely monitor implementation of the plan by setting up two independent monitoring groups, one in Romania, one internationally, in close cooperation with the international financial institutions.

To prove its determination, the Romanian Government, with the support of all political parties, also unilaterally set January 1, 2007 as the date when Romania should be ready to become a member of the European Union. The date takes into consideration:

The Pre-Accession Instruments


Within the 2000 PHARE budget, Romania will benefit from assistance amounting to €251 million distributed between a national program, community programs, and cross-border co-operation (Hungary and Bulgaria).

The biggest amount (€215 million) is allocated for the PHARE national program, which focuses on the following priority areas: (a) “institution building,” including twinning projects; (b) converging with the acquis on areas such as strengthening the judicial system and civil society development, liberalizing the electrical power and gas sectors, strengthening the institutional capacity of the Ministry of Agriculture, improving border management, and the fight against drugs; and (c) regional development.

Financed out of a PHARE national budget, twinning projects with a EU member country consist of a bilateral partnership between a member country and an applicant for strengthening the institutional development, aiming at creating a public administration able to apply the European acquis at the same standards than the EU member states.


This pre-accession instrument, taking as reference model the Cohesion Fund, foresees an allocation for Romania up to €240 million. The budget will be allocated for projects in the areas of transport and the environment.

In order to access the ISPA funds starting as of 2000, the Ministry of Transport elaborated the “ISPA National Strategy 2000-2006 in the Transport Sector” in the framework of the National Development Program for Accession to the European Union. Priorities in the field of transport are concentrated on improving the infrastructure on the trans-European corridors.

As regards the environment, the main objective of the investment projects is to support the Romanian government in ensuring compliance with the “heavy” acquis communautaire in fields such as drinking and waste water standards as well as air pollution.


Within the SAPARD pre-accession instrument, Romania can benefit as of 2000 from an annual allocation up to €150 million. SAPARD will function along the same model as the European Agricultural Fund—the agricultural subsidy system in the EU. It will support projects in the areas of rural development modernize infrastructure, tourism and the agro-food industry (notably quality). It will target private entities, especially small farmers.

Figure VI.1.
Figure VI.1.

EU Pre-Accession Annual Resources in Central and Eastern European Countries (in million of euros)

Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A006

Table VI.2.

Annual Distribution of EU Pre-Accession Aid Between Central and Eastern European Countries

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Source: EU Commission, Euroslat.Note: This table indicates the program allocations budgeted by the EU Commission in 2000, not the disbursements. For SAPARD and ISPA, a roughly equivalent budget allocation is planned during the period 2000-2006 and for PHARE during the period 2000-2002.

GDP in 1998 at current prices

Central scenario. The EU Commission has projected three scenarios by countries: Romania is to receive an annual allocation between €208 and €270 million.

Priority given to development expenditures

7. In allocating a large volume of its pre-accession resources to Romania, the European Union has taken into consideration the size of the population, the relatively low level of development of the country, and the need for high and sustained economic growth. If Romania is to converge to Western European living standards, the upgrade of the institutional and physical infrastructures needs to be accelerated. EU annual budgeted allocations to Romania during the pre-accession period (2000-2006) are expected to be roughly distributed as follows: PHARE (€240 million); ISPA (€208-270 million); and SAPARD (€150 million). Thus, the share of grants to Romania has been oriented in priority toward development projects—ISPA (transport, water supply and environmental infrastructure), SAPARD (agriculture and rural development), as well as the regional development component of PHARE. The total amount of resources allocated (through PHARE programs) to institution building and the adoption of the acquis is somewhat less significant, though it is likely to increase at a later stage.10

8. The priorities set by the EU can be illustrated through the GDP composition between Romania and the EU. In 1999, the share of agriculture in GDP was 13.9 percent in Romania, compared with 2.3 percent in the EU. In terms of employment, farmers represent by far the largest share of the active population (40 percent, or ten times the level in the EU). Preparing for integration requires large agricultural support programs to increase efficiency and gradually apply relevant EU standards. Moreover, the weight of the industrial sector represents some 28 percent, and the services and construction sector account for 58 percent of the gross value added (compared with, respectively, 31 percent and 67 percent in the EU). It is for this reason that 29 percent of the budget allocated by the EU to SAPARD for candidate countries is earmarked for Romania (compared with 22-23 percent for PHARE and ISPA). With the exception of Poland, which receives 32 percent, this is three times more funding than any other country receives, and the highest allocation per capita (Baltic states excluded).

9. In addition, to the pre-accession instruments, the EU provides resources to support the implementation of the structural adjustment programs agreed with the World Bank and the macroeconomic stabilization program supported by the International Monetary Fund. From 1990 to 1999, the EU provided Romania with €680 million of macro-financial assistance. In 2000, a tranche of €100 million was granted in June upon approval of the first review of the stand-by arrangement and a second tranche of an equivalent amount is to be disbursed upon approval of the second review of the stand-by arrangement. €100 million was also provided through RICOP,11 a program financing social safety nets in the context of the restructuring (liquidation/privatization) of the public companies. This reflects a large degree of overlap between the accession agenda and measures to strengthen economic management, as well as complementarity between reforms designed to facilitate accession and inevitable structural reforms.

Strengthening absorption capacities

10. To absorb the additional volume of EU grants, the Romanian Government needs to take a number of necessary fiscal and institutional measures.

11. On the fiscal front, both ISPA and SAPARD require co-financing, as the support of the European Community cannot exceed 75 percent of the value of the project. In the case of SAPARD, the co-financing element must come from the national, regional (judet) or local budget, while for ISPA the co-financing element may also be provided by international financing institutions and interested commercial banks. The PHARE projects financing investments will also require co-financing from national public funds and the EU contribution will be limited to 75 percent of the public expenditures. The additional direct cost for the budget will amount at a minimum to €100-150 million, equivalent to 0.5-0.7 percent of GDP. In addition, one should take into account the indirect maintenance cost to ensure the functioning of the projects following their implementation.

12. As regards institutional measures, solid and transparent policymaking and administrative capacities needed to be established. The new aid instruments represent a major change since there are three programs with more than twice as much funding, as well as different rules for each instrument. ISPA requires the preparation of strategies for both transportation and the environment, as well as a financing memorandum for each project, rather than a financing memorandum covering an entire program (as is the case under PHARE). SAPARD requires a paying agency to be set up (which on accession will be responsible for the management of the EU’s agricultural fund). Different regional agencies may be needed, as SAPARD support goes to individual farmers. Project management capabilities, financial management structures, and public procurement systems have to be built.

13. Modifications to Romanian national financial control have been adopted in line with the requirement of the pre-accession funds. But the move to ex post financial control will be made by the Commission only when it deems the system fully operational. The Romanian government experiences difficulties in setting up the relevant administration eligible to manage the funds and there will be delays in starting the SAPARD projects. Moreover, many of the possible SAPARD projects that are to be selected rely on the financing through regional (judet) and local budgets, where co-financing possibilities are very limited, in part because of weak financial management. It is therefore likely that disbursements for ISPA and SAPARD will not start before 2001 (at the earliest for the latter).

The Stability Pact projects: An additional volume of resources

14. Romania and Bulgaria are the only two countries that belong both to the group of countries invited to negotiations to EU accession and beneficiary parties of the Stability Pact for South-Eastern Europe. The two countries have been affected by two main political developments in the region. First, the sanctions decided by the UN as of 1994 against the Federal Republic of Yugoslavia through a gradual embargo on goods (and then services) have reduced trade relations with a neighboring country and shrunk economic activity in the border areas. Second, following the start of the war in Kosovo, the destruction of bridges has hindered navigation on the Danube River, thereby freezing the emerging activity of the shipping companies that had been recently privatized. Romania and Bulgaria, therefore, became beneficiary countries of the Stability Pact, which aims at promoting a comprehensive regional development approach to the Balkans. This also meant further resources, mainly in the form of grants, in the context of new funding of programs and projects. The source of these funds comes in the first place from the EU, either through bilateral aid, the budget of the Commission, or its financial arm, the European Investment Bank.12

15. In March 2000, donors participating in the Regional Funding Conference for South-Eastern Europe considered a first round of projects and programs for the development of the Balkans. Individual countries and multilateral institutions pledged €2.4 billion of financial support to the Quick Start projects, of which half of the funds were estimated to be in the form of grants. Quick Start projects are expected to begin within a year and are mostly geared to upgrade infrastructure, promote trade, and encourage investment. Romania’s Quick Start program consists of two road infrastructure projects, for an amount of €332 million, or some 30 percent of the total funding of projects.13 Its other “near-term projects,” which will be considered subsequently for funding, amount to €770 million or 28 percent of the projected total cost. To date, Romania is the leading beneficiary country of the Stability Pact in terms of volume of aid pledged.14

C. On the Way to Accession

Establishing a “functioning market economy”

16. The degree of state ownership in the economy is often a good indicator of whether a market economy is free of distortions and functions properly. The state maintains an important role in the Romanian economy, in particular through its ownership of large companies. The share of the private sector in production has remained constant at about 61 percent of GDP since 1997. In mid-2000, about 60 percent of large companies (in terms of State Ownership Fund (SOF) capital) remained to be privatized. In addition, all utilities remain in state hands, with the exception of ROMTELECOM. The lack of financial discipline of public companies and their high level of arrears has turned into a major distortion for the Romanian market, while hampering the privatization process. Moreover, despite the high degree of estimated private land ownership (about 85 percent), the government also remains a key actor in the land market, mainly as a result of the lack of progress on the issue of restitution of agricultural land and forests and the deficiencies of the land cadastre. The law on the restitution of state arable land and forests was promulgated in January 2000, but implementation remains slow.

17. The existence of fair access to market financing is a second indicator. Progress in this area would require privatization of the banks and strengthening of supervision activities. The privatization process has started in the last two years, with two state-owned banks and the closure of another one. Two commercial banks owned by the government, representing at end-1999, respectively, 29.1 percent and 4.2 percent of the total assets of the banking sector, as well as the savings bank of the country (10.6 percent of the total assets), are still owned by the government. Provided the government remains committed to the process of bank privatization, it should be possible to complete the privatization of the two commercial banks by 2001. The National Bank of Romania has also embarked on a reform to consolidate the supervision of the banking system.

18. Transparency in the market—namely whether the government is able to regulate the market in order to ensure fair competition—is another indicator of whether the economy functions properly. Admittedly, some share of the Romanian economy is unregulated, with the emergence of a parallel economy that has developed rapidly in recent years. According to various studies that have been carried out to assess its size, the parallel economy could represent between 20 percent and 40 percent of Romanian GDP, reflecting some of the weaknesses of the transition process.15 As regards competition rules, the European Commission stated in its progress report in 1998 that “Romania’s Competition Law is largely in line with EU legislation,’” but called for “efforts toward full and effective application of the legislation.” The same remarks apply to state aid and public procurement, as the new law that entered into force in 2000 transposes most of the acquis communautaire, A related issue is the ability to protect intellectual property rights. Under the Europe Agreement, Romania made the commitment to provide by 2000 a level of protection of intellectual property rights similar to that in the EU. The government acknowledges that effective enforcement remains a challenge and intends to allocate additional resources allocated to this purpose.

19. A fourth indicator is the degree of price liberalization, where progress has been positive so far. The prices of most goods are freely set, with the notable exception of gas prices and utilities, which account for about 11 percent of the total consumer price index basket. Controlled prices have been periodically adjusted, though not always with the same frequency in the last 12 months.

20. Finally, a legal environment conducive to business activities is a key aspect. In the context of the acceleration of structural reforms, the authorities introduced a number of important legislative changes, including modifications to the company law and the bankruptcy law, and to the legal regime for leasing operations, as well as new laws on secured transactions. In general, though, the weaknesses of the legal and judicial framework continue to hinder the development of economic activity and encourage the emergence of a parallel economy.

21. Against this background, notwithstanding considerable progress in stabilization and structural reform over the past two years, the Commission noted in October 1999 that “Romania cannot be considered to be a functioning market economy,” and conditioned a revision of this assessment on many legal and institutional changes and achievement of macroeconomic stability.

Consolidating trade and foreign investment, and liberalizing capital flows

22. Trade is among the areas where Romania is most integrated with the EU. Much progress has been made toward the liberalization of the sector and the reduction of tariff barriers. The composition of external trade and its geographical structure have gradually shifted, thereby providing the conditions for a smooth transition to the EU single market. As regards the latter, Romania is driven by the implementation of the Europe Agreement, a free-trade agreement that requires the elimination of remaining tariffs on nonagricultural imports from the EU by 2002 (see Box VI.3) and gradual reciprocal tariff reductions for agricultural products. Meeting this commitment will not be unduly difficult, as tariffs on industrial products are relatively low, with an average most favored nation rate at 16 percent (well below the upper limits defined jointly with the WTO of some 35 percent) and a preferential rate of 7 percent on average for imports from the European Union (see Table VI.3).16 The phasing out by 2002 is likely nevertheless to lead to more intense competition on the domestic market, as the tariff elimination was back-loaded for sensitive products such as footwear, and textile and clothing products. On agricultural products, the liberalization of tariffs has been substantial in recent years, since Romania applied up to 1997 the limits applicable for the most favored nation (MFN) tariff rates agreed with WTO—an average bound rate of 134.1 percent—and brought it down to 33.9 percent. However, there is no significant preferential tariff applied so far to the European Union and the cost of tariff elimination on agricultural goods might be more significant for Romania. The two parties are committed through the Europe Agreement to move gradually toward (asymmetric) concessions and tariff reduction.17 Romania is also committed to eliminate most tariff barriers with EFTA and CEFTA countries. As regards the latter group, tariffs on industrial products are virtually down to zero and on agricultural products, at some 23 percent. Finally, the issue of application of the EU third-countries tariff to non-EU countries with which Romania is committed in trade arrangements (Moldova, Black Sea countries) will need to be settled. As regards temporary measures, Romania ended the practice, which had intensified in 1995-96, of tariff reductions subject to quotas. All remaining quantitative restrictions on exports have been eliminated and replaced with automatic licensing for statistical purposes. In addition, no anti-dumping, countervailing, or safeguard measures have been taken under the WTO Agreements. The import surcharge, which was introduced in 1998 at 6 percent, is gradually being phased out and is expected to be eliminated by January 1, 2001. The new Customs Code of 1997 unified the regime for importers and exporters in a single framework. It converges with the EU’s Customs Code, as the principles of customs valuation are largely the same. Comparison values were used until 1998 for products subject to excise taxes, but were replaced in 1999 with a data base of prices.

Romania and Free-Trade Agreements

Romania has concluded free-trade agreements with the European Union, EFTA, CEFTA, Moldova, and Turkey.

Entering into force in 1995, the Europe Agreement with the European Union, aims at accelerating the economic integration of Romania. The basic principles of the agreement are:

The Europe Agreement allows the Romanian economy to prepare for the moment of accession. The asymmetry of the concessions provides the basis for an increase of industrial product exports to the EU, thus positively influencing the process of productivity increase through the use of new technologies. At the same time, the need to observe internationally accepted rules improves the commercial behavior of the Romanian exporters.

The Free Trade Agreement with the EFTA States is largely patterned on the trade provision of the Europe Agreement.

The process of regional integration is consolidated by the accession of Romania to the Central European Free Trade Agreement (CEFTA), on 1 July 1997. The CEFTA countries, all “front-runners” to EU accession, agreed before the entry of Romania, to complete trade liberalization among themselves by 2001. Without changing that objective, the CEFTA countries aim at gradually eliminating customs duties reciprocally with Romania by 2002.

Romania is also a member country of the Black Sea Economic Cooperation, which promotes trade in the Black Sea area.

Table VI.3.

Romania: Average Tariffs in 1999

(In percent)

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Source: World Trade Organization (WTO).

Upper limit set with WTO.

23. In line with EU requirements, excise taxes are levied on alcoholic beverages, tobacco products, and petroleum products (as well as a general category of other products). Although excise duties were increased in December 1999, their level remains low in relation to EU levels. The government is wary that relatively high levels of duties and taxes could contribute to smuggling and customs fraud. Also, the strengthening of border controls is perceived as complicating customs procedures, often described as complex, cumbersome or time-consuming. As regards VAT, Romania has applied a uniform VAT rate of 19 percent since January 2000 (see Chapter II).

24. An indicator of Romania’s preparedness for EU accession is the level of its commercial integration with the EU, reflecting, as the Commission states it, the “capacity to cope with competitive pressure and market forces within the Union.” Romania’s commercial relations with the EU became predominant beginning in 1995 (see Table VI.4). The share of exports to EU countries in the total Romanian exports increased from 33.9 percent in 1990 to 65.5 percent in 1999. The same trend was registered for Romanian imports from EU countries, whose share in total Romanian imports was 55.1 percent in 1999, compared with 21.8 percent in 1990. Among the candidate countries in 1999 (including Turkey, Cyprus, and Malta), Romania was both the sixth largest destination for exports and the sixth largest source of imports. On a per capita basis, however, EU trade with Romania is the lowest among candidate countries and the trade balance has, since 1993, been positive for the EU.18

Table VI.4.

Composition of Romanian External Trade with the European Union, 1990-99

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Source: National Commission for Statistics.

25. The analysis of Romania’s trade with the EU from 1990 to 1999 illustrates the important structural changes in the country’s economy. Export activities have shifted from capital- and energy-intensive industries to labor-intensive manufactured goods with a low value added. There has been, therefore, a substantial decline in exports of mineral and chemical products, a surge of exports of textiles, footwear, and wood products, and an increasing reliance on imports of raw materials for these industries from the EU (fabrics, hides, skins, etc.). In central and eastern Europe, Romania is the largest exporter of clothing products to the EU.

26. As regards foreign direct investment, the investment regime is broadly liberal. All investors, domestic and foreign, benefit from a general guarantee against nationalization and expropriation. In principle, there is equality between foreign and domestic investors in establishing a Romanian company and foreign direct investments are free (except for the oil exploitation and insurance sectors), as are investments in real estate for business purposes.19 Notwithstanding these provisions, foreign direct investment played only a minor role in Romania’s transition between 1989 and 1996 (a total of US$1.7 billion), with levels becoming more significant only in 1997 (US$1.3 billion) and 1998 (US$2 billion) and below US$1 billion in 1999. The relatively low level of foreign direct investment to date has been an obstacle to the modernization of the capital base and creation of jobs in the private sector. The status of Romania as an EU candidate should enhance its attractiveness to foreign investors.

27. Turning to foreign exchange regulations, Romania enjoys full convertibility of current account transactions (Romania accepted the Article VIII obligations in March 1998). However, there are still in practice some constraints on capital account transactions: Romania applies an authorization procedure for most outward capital transactions as well as short-term capital inflows.20 In choosing to limit short-term capital inflows, the government wants to prevent instability in the foreign exchange market. In July 1999, to prepare for integration to the European capital market, the National Bank of Romania approved a three-stage liberalization program, to be completed by the date of accession. The first stage envisaged would encompass the liberalization of capital inflows, excluding short-term operations (such as transactions with money market instruments, securities issued or guaranteed by public entities, and the placement of deposits in lei by nonresidents), and the second stage would include the liberalization of capital outflows. The timetable for the two stages is not yet finalized; it is understood that when Romania joins the EU, it will need to have completed the third stage by opening its capital account fully.

Joining EMU: Implications for Romania

28. The European Commission now considers the participation in EMU an integral part of the acquis while the EU member countries have decided that no more opt-out clauses from-EMU will be granted to candidate countries. As 2007 is the date set by the Romanian Government to join the EU, the question of the implications of the accession to the EMU is therefore not premature. But a clear distinction should be made between compulsory participation in the EMU and the adoption of the euro as a single currency. In its 1999 Composite paper on progress toward enlargement, the Commission stated that “new-Member States are not expected to adopt the single currency immediately upon accession, even though they will be taking part in EMU”. Upon accession, the newcomers will have the status of Member States with a derogation under the rights and obligation, specified under article 122 of the Amsterdam Treaty, of a country which takes part in EMU but which still uses its national currency. With an insufficient degree of real economic convergence and financial integration, newcomers may be confronted with asymmetric shocks with respect to the euro area. Priority should therefore be given to consolidate the well functioning of markets as well as to macroeconomic stability in order to reach a high degree of sustainable convergence. As noted by the Commission, “there is a risk that candidate countries will rigidly orient their policies towards compliance with the Maastricht convergence criteria in an effort to adopt the euro at the earliest possible opportunity.”

Institutional and legal requirements

29. To comply with the acquis and fully access the EMU (Stage III), the Romanian government will need to take four main institutional and legal requirements into consideration, unless the EU countries grant a transitory period.21 The liberalization of capital flows and an efficient financial sector will be instrumental in building the capacity to join the EMU and subsequently the euro area.

30. The first key pre-condition in joining EMU relates to exchange rate policy. Prior to accession, Romania is free to choose whatever exchange rate system suits it, although admittedly the system should be appropriate in facilitating economic and financial convergence to the EU. Upon membership, a new member is obliged to avoid exchange rate fluctuations and competitive devaluations. This is why in principle, though on a voluntary basis, a newcomer is likely to enter the exchange rate mechanism (ERM II), a system established to maintain the exchange rate of the currency of the applicant member country against the euro within a band (±15 percent) around the central rate. This would imply for instance that Romania’s macroeconomic parameters enable the country to modify its floating exchange rate system to join ERM II.

31. Second, the central bank must be able to formulate monetary policy without government interference so as to meet its primary objective, the maintenance of price stability. The central bank should also comply with rules on the appointment, dismissal, and term of office of the governor. In Romania, the independence of the central bank is functional but remains conditional.22 The law on the National Bank of Romania (NBR) remains, among the ten candidate countries, the only one that has no explicit reference to independence (reportedly out of concern that it might have been interpreted as “iinaccountability”). The NBR nevertheless freely chooses the instruments and techniques of monetary control and exchange rate policy, which ultimately lead to price stability.23 As regards political independence, the Governor, as well as the members of the Board, are appointed for six years and are accountable to the Parliament.24

32. Third, countries joining EMU must renounce all forms of direct central bank financing of government deficits. Romania has relatively restrictive rules. Overdrafts are permitted but for a limited amount (7 percent of state budget revenues, or about 1.2 percent of GDP in 1999), and a short maturity.25 The purchase of national government securities by the central bank in the primary market, as well as the privileged access of public authorities to financial institutions, are implicitly not allowed but not explicitly prohibited by the law.26

33. Finally, the smooth functioning of the financial sector and the ability to cope with free but volatile movements of capital are critical and part of the EMU acquis. The prospect of EU membership will increase pressure to make progress toward developing a healthy, efficient and market-oriented financial sector.27

Maastricht criteria

34. The Commission noted in 1999 that “attempts at too early adoption of the euro (i.e. before these economies have reached a high degree of sustainable convergence) could be highly damaging for the candidate and ought to be discouraged.” In this regard, it would seem too early to assess Romania’s macroeconomic convergence through the Maastricht criteria. Sustainable nominal convergence is more likely to be judged when Romania will have demonstrated its capacity to successfully operate within the single market and liberalized capital movements, as was the case with existing member countries.

35. Looking ahead, Romania’s performance gap in terms of the Maastricht criteria as compared to most other candidate countries may, however, raise difficulties for the EU (Table VI.5). Romania’s inflation rate is not only much above the EU average, but at the highest average level among the applicant countries since the transition process has started. The inflation rate reached an annual average of 123 percent in the period 1991-99, and has never declined below 30 percent, a threshold that will remain unchanged in 2000. Romania’s fiscal policy may appear rather tight and in line with the target set by the Maastricht criteria, with the average general consolidated budget balance reaching a deficit of slightly above 3 percent of GDP since the start of the transition period, but this measure does not reflect large quasi-fiscal costs related to public companies’ debts. In the years ahead, fiscal balances will be burdened by the cost of the bank restructuring and the much delayed restructuring of the public sector, with considerable hidden debts in the form of arrears. Interest rates, which have been among the highest of the group of candidate countries in recent years, are likely to remain high until Romania’s inflation converges to EU levels. It should be noted that a long-term interest rate indicator is lacking; ten-year bonds still do not exist and the longest maturity in Romania is currently the two-year treasury note, reflecting the overall lack of confidence in government paper, of the short term structure of bank deposits in an inflationary context, and the shallowness of the capital market. Romania meets consistently only the convergence criteria related to the level of the government debt to GDP, a ratio close to zero in 1990, which rose to some 30 percent of GDP in 1999, less than half the EU average, and is largely contracted on short- and medium-term maturities.

Table VI.5.

Maastricht Criteria: Convergence Indicators

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Sources: EBRD IMF; and World Bank.

Average for 1993-96.

Average for 1994-96.

Lending interest rates, year average; except for the EU (government bond yield).

36. In meeting one convergence criterion out of four and experiencing a recurrent instability of its nominal and real exchange rates, the question of Romania’s convergence to the macroeconomic parameters of the EU member countries is rhetorical in the short and medium run, though it remains a benchmark in a longer horizon. The main conclusion of this chapter is that stabilization is a prerequisite and macroeconomic stability needs to be achieved to build up a macro-performance record that will convince EU member countries about the sustainability of the convergence track. This will require tight fiscal and monetary policies that will need to be reconciled with development and public investment needs. To this end, Romania will benefit from a substantial share of the resources made available by the EU during the pre-accession period. It will be important to promptly use, and efficiently absorb, the EU pre-accession transfers to upgrade the country’s infrastructure and to set the conditions to boost the economic growth indispensable to real convergence.


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Table 1.

Romania: GDP by’ Origin, 1993-99

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Source: National Statistics Commission.

From 1993, “Trade” includes hotels and restaurants.

Table 2.

Romania: GDP by Expenditure, 1993-99

(In percent)

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Source: National Statistics Commission.
Table 3.

Romania: Investment by Sector, 1993-99

(In billions of lei at current prices)

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Source: Data supplied by the Romanian authorities.

For 1996 and 1997, ”Trade “ includes hotels and restaurants.

Table 4.

Romania: Saving-Investment Balance, 1993-99

(Current prices)

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Sources: National Statistics Commission; and Fund staff estimates.
Table 5.

Romania: Employment in Agriculture (Including Self-Employed), 1993-98

(In thousands of persons, end of year)

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Sources: Ministry of Agriculture and Food; and National Statistics Commission.
Table 6.

Romania: Distribution of Land Ownership, 1993-99

(In thousands of hectares)

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Source: Ministry of Agriculture and Food.

Out of 9,200 hectares of land covered by the Land Law.

Table 7.

Romania: Output of Main Agricultural Products, 1993-99

(In thousands of tonnes, unless otherwise indicated)

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Source: Data provided by the Romanian authorities.
Table 8.

Romania: Industrial Production Index, 1993-99 1/

(Average 1991=100) 1/

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Source: National Statistics Commission.

Unadjusted series.

1991-1993 are in structure 1989.

1994-1997 are in structure 1991.

1998-1999 are in structure 1995

Table 9.

Romania: Number of Employees by Sector and Type of Ownership, 1995-98 1/

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Source: Data provided by the Romanian authorities.

Excludes the self-employed.

Distribution by sector of private employees.

Table 10.

Romania: Enterprise Payment Arrears, 1995-99

(in percent of GDP)

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Sources: Romanian Ministry of Finance; and Fund staff estimates.

1995 stocks and flows are understated owing to the writeoff of: some arrears as part of the FESAL debt conciliations in Fall 1995.

Lei 7,875 billion have been added to the December 1997 figures to adjust for the writeoff associated with Bancorex and Banca Agricola.

Other arrears, including e.g. wage arrears, dividend arrears, and, arrears to the social security, pension and unemployment funds.