1. This supplement reports on new information that has become available since the issuance of the staff report (EBS/03/48, 04/11/03). The staff appraisal remains appropriate and the staff reaffirms its recommendation that the review be completed. All prior actions were met well ahead of the five day deadline before the Board meeting. However, end-March monetary indicative targets were not observed, suggesting a need for some tightening of liquidity.

2. Macroeconomic developments remain consistent with the program, despite some weakening of activity. Inflation in March remained subdued at 1.1 percent, fully consistent with the authorities’ end-year target of 14 percent. In February, industrial production declined by 2 percent on a 12-month basis, for the first time since April 2002, reflecting the effects of weak growth in the EU, but also disruptions in supply in the metallurgy sector. Net wages in monitored state-owned enterprises (SOEs) in February were higher by 11¼ percent in real terms than a year ago. In addition to the effects of the minimum wage increase, this figure reflected the conclusion of many collective contracts, and the corresponding adjustment in wages, somewhat earlier in the year compared with 2002. Staff expect wage growth to moderate as the year progresses.

3. The general government deficit in Q1 was substantially below the target, but the government has postponed the decision on increasing fuel excise tax rates. According to preliminary data, following good performance in January and February, revenue was weaker than expected in March, and the collections for Q1 were below the program. As spending was contained, the deficit of the general government came out at 0.3 percent of annual GDP, about ¼ percent of GDP less than targeted. Unfortunately, the government also decided to postpone the decision on restoring fuel excises back to their pre-February levels, which was agreed in the Supplementary Memorandum on Economic and Financial Policies. Instead, they decided to implement several measures to address large scale smuggling of fuels, including by limiting imports to specific custom posts and prosecuting non-payment of excises under the criminal code. Should the collections not improve by early June, the authorities have announced that excises would be raised as of June 15. While welcoming the measures against smuggling, staff regret the decision not to increase the excise tax rates, which was expected to provide about 0.15 percent of GDP in additional revenue, and note that this action would likely necessitate other compensatory measures to ensure that the 2003 budget deficit target is met.

4. The indicative monetary policy targets for end-March were not observed. NFA remained flat in Q1, and the floor was missed by about US$170 million. NDA exceeded its ceiling by 8 percent, and reserve money was 3 percent above target. Facing larger than expected outflows, the nature of which has yet to be identified, the NBR gave priority to sticking to its main disinflation tool, the exchange rate, instead of purchasing foreign exchange in the market, taking comfort from the large overperformance in NFA over the last two years. As a result, the exchange rate path has remained broadly in line with the program. The authorities attributed the overshooting of the reserve money target to an increase in demand for currency as a reduction in the number of NBR cash distribution offices has made the access to cash in some areas more difficult.

5. In staffs view, the NBR should refrain from further cuts in interest rates and strengthen efforts to sterilize liquidity. In February, staff advised the authorities against reducing the policy interest rate until the effects of the minimum wage increase could be better assessed. However, the rate dropped from 20 to 19 percent on average in March, while the NBR did not accept all bids at its deposit-taking auctions, effectively further easing monetary conditions. During the recent Spring meetings, the authorities agreed that additional efforts needed to be made toward mopping up liquidity in the banking sector, including increasing intake at deposit auctions. Since mid-April, the policy interest has been maintained at 20 percent.

6. The effect of recent further slowdown in Europe on Romania is expected to be modest. The robust export performance in 2002 suggests that the moderate export growth projected in 2003 remains within reach, although the downside risks for export and GDP growth are now stronger. On the other hand, the lower-than-expected trade deficit in January-February and the recent downward revision in international oil price projections for 2003 provide a welcome cushion in the current account projections.