Romania: Ex-Post Assessment of Longer-Term Program Engagement

This paper reviews the experience of the IMF’s long-term engagement in Romania and options for future IMF involvement. The unfavorable growth performance also reflected adverse conditions for private sector development. Foreign investors have welcomed the more stable macroeconomic environment and the tax legislation overhaul under the recent Stand-By Arrangement. Although the overlap between Bank and IMF conditionality in the area of structural reforms was not conducive to reducing the number of conditions, it helped increase the pressure on the authorities to maintain the reform momentum.


This paper reviews the experience of the IMF’s long-term engagement in Romania and options for future IMF involvement. The unfavorable growth performance also reflected adverse conditions for private sector development. Foreign investors have welcomed the more stable macroeconomic environment and the tax legislation overhaul under the recent Stand-By Arrangement. Although the overlap between Bank and IMF conditionality in the area of structural reforms was not conducive to reducing the number of conditions, it helped increase the pressure on the authorities to maintain the reform momentum.

I. Introduction

1. This paper reviews the experience of the Fund’s longer-term engagement in Romania and discusses options for future Fund involvement. With six Stand-by Arrangements (SBAs) since the beginning of the 1990s, Romania has been a prolonged user of Fund resources, thus requiring an assessment of the Fund’s longer-term involvement (SM/03/233). In part, this ex-post assessment builds on the findings of a Country Strategy Paper (CSP) prepared by staff in June 2003, which assessed progress since the previous CSP in 1997. The focus of this paper is on Romania’s more recent engagement with the Fund.2

2. Since the beginning of the transition, the approach of successive governments to macroeconomic stabilization and reform has been hesitant and piecemeal. This, together with the burdensome political and economic legacy of the Ceausescu era, has produced a weak record of policy implementation under the five SBAs in 1991–2000 and made Romania a laggard among EU accession candidates. While none of these programs was completed, important progress was made under the two SBAs from 1997–98 and 1999–2000, laying the foundation for stronger performance under the 2001–2003 SBA.

3. Recently, the government’s strong commitment to EU accession has served as an anchor for economic policy. While policy implementation improved, as the authorities became increasingly aware of the scope and the urgency of reforms required to keep EU accession on track, ownership has remained mixed with respect to a number of key structural reforms.

II. Achievements and Shortcomings Under Fund-Supported Programs

A. The 1990s: Slow Progress in Macroeconomic Stabilization and Structural Reforms

4. Romania started the transition to a market economy under difficult initial conditions. Even though Romania’s external public debt had virtually been repaid by the end of the 1980s, the legacy of Romania’s communist regime was particularly poor, with very rigid central planning, a massive misallocation of resources—particularly in energy-intensive industries and agriculture—and a heavily obsolete capital stock. State-owned enterprises (SOEs) were highly inefficient and engaged in massive quasi-fiscal activities. Given these circumstances, a lengthy transition was unavoidable.

5. These disadvantages were exacerbated by weak macroeconomic stabilization efforts and slow structural reforms prior to the 1997 SBA. Following a combination of an output contraction and inflation burst in the early years of transition, in 1994 Romania’s growth performance improved and inflation started to decline. These developments were, however, based on large subsidies to inefficient, and in many cases unviable state-owned enterprises (SOEs), rising fiscal deficits, and surging quasi-fiscal losses that aggravated the underlying macroeconomic imbalances by late 1996 and led to the banking crisis of 1997–99. External debt rose rapidly from the negligible levels at the start of the transition process.

6. Difficulties in reforming SOEs were central to Romania’s slow progress and uneven macroeconomic performance. Large vested interests, in particular the collusion between the trade unions, management, and factions within the ruling parties, have been a crucial factor for excessive wage growth and the lackluster privatization performance, with the privatization of large SOEs only starting in 1997 and proceeding very slowly thereafter.

7. Accommodating losses from quasi-fiscal activities persistently undermined stabilization policies. Significant overvaluation of the leu, which subsequently required large corrections, tolerance of large arrears initially between enterprises and/or to the banks, and later to the budget and utilities, and the large directed lending to ailing SOEs in industry and agriculture periodically whipsawed domestic demand and undermined macroeconomic stability and financial sector stability.

8. The unfavorable growth performance also reflected adverse conditions for private sector development. The much slower private sector development compared to other EU accession countries reflected the lack of macroeconomic stability, mayhem in the area of tax policy, weak enforcement of property rights, and the prevalence of weak governance. These factors were also responsible for low FDI inflows compared to other countries in the region (Figure 1).

Figure 1.
Figure 1.

Selected EU Accession Countries: Comparison of Economic Indicators, 2002

Citation: IMF Staff Country Reports 2004, 113; 10.5089/9781451832747.002.A001

Sources: World Economic Outlook, Global Development Finance 2002, World Bank and Transition Report 2003, European Bank for Reconstruction and Development.1/ EBRD transition score, averaged across enterprise, markets, infrastructure and financial institutions.

9. Notwithstanding some key reforms by a newly elected government in 1997, the Romanian economy soon veered back toward financial instability. In early 1997, prices and the exchange and trade regimes were liberalized and quasi-fiscal subsidies through the National Bank of Romania (NBR) were terminated. The government also attempted to rein in fiscal spending. However, the authorities soon relaxed fiscal and wage restraint and relied instead on slowing the lei depreciation to contain inflation. A weakening current account and deteriorating investor confidence, exacerbated by the Russian crisis, led to heavy reserve losses and mounting concerns of a default on privately held bonds. As a result of the ensuing currency crisis, real GDP fell by 12 percent from 1997 to 1999, inflation averaged 72 percent, and gross reserves fell by over US$1.0 billion (Figure 2). Largely on account of difficulties in raising public sector savings on a sustained basis, the current account deficit was very volatile.

Figure 2.
Figure 2.

Romania: Key Macroeconomic Variables

Citation: IMF Staff Country Reports 2004, 113; 10.5089/9781451832747.002.A001

10. High and variable inflation in 1997-2000 reflected inconsistent macroeconomic policies and reluctance to tackle quasi-fiscal losses. In early 1997, the NBR attempted to reduce inflation by using foreign exchange market intervention to slow down the depreciation rate. However, without sufficient support from fiscal policy and, in 1998, wage restraint, this attempt failed after heavy reserve losses in late 1998. The ensuing disorderly exchange rate depreciation thwarted disinflation efforts in 1999–2000, via both the direct pass-through effect on the domestic price level and a surge in inflationary expectations. Throughout the period, the large loss-making SOE sector was kept afloat by a combination of implicit acceptance of non-payment of taxes, directed lending from state-owned banks, and maintenance of below-cost energy prices, all of which contributed to raising domestic demand to excessive levels and thus to high inflation. In turn, high inflation disguised the true cost of failing to reform the SOEs by ultimately distributing their losses over the whole society.

B. Recent Macroeconomic Developments

11. Confronted by the currency crisis, the authorities took decisive policy measures in 1999 to stabilize the economy. Fiscal and real exchange rate adjustment laid the groundwork for improved macroeconomic performance. Following feeble attempts in 1997 to address the issue of directed lending and lax bank lending standards that resulted in a rapid accumulation of non-performing loans, the authorities finally resolved the banking crisis by terminating directed lending, closing the biggest state-owned bank Bancorex, transferring most of the non-performing loans to an asset recovery agency, recapitalizing other stateowned banks, and tightening banking supervision. This helped lower the current account deficit to sustainable levels, and laid the basis for recoveries in export, investment and real GDP growth. International reserves were rebuilt, and the soft unannounced crawling band regime anchored a steady decline in inflation since 2000.

12. Since mid-2001, Romania has enjoyed a period of strong real GDP growth and steady, if gradual, disinflation. Budget and wage restraint and energy price adjustments moderated domestic demand and earned greater credibility for stabilization policies in general. This allowed the NBR to successfully guide exchange rate depreciation on a downward path, both alleviating the cost-push effect and moderating inflationary expectations. As a result, inflation declined from 40 percent in early 2001 to 14 percent at end-2003, but still remains high compared to other EU accession countries. The gains in external competitiveness achieved by the 1998–99 correction in the exchange rate (Figure 3) have been largely preserved through sizable productivity increases, moderate growth in economy-wide wages through 2002, and cuts in social security contribution rates from 60 to 49.5 percent during 2001–04. The annual average unemployment rate declined from 9 percent in 2001 to 7.6 percent in 2003 against the background of a steady decline in the labor force and a slight increase in salaried employment.

Figure 3.
Figure 3.

Real Effective Exchange Rates

(3-Month Moving Average; 1998=100)

Citation: IMF Staff Country Reports 2004, 113; 10.5089/9781451832747.002.A001

Sources: Romanian authorities, and Fund staff estimates. CP I based measures use INS weights, while ULC-based REER includes advanced economy partners only.

13. However, the current account deficit has recently widened as a result of a boom in private sector credit and an excessive minimum wage increase. In 2003, the current account deficit surged to 6.1 percent of GDP (in U.S. dollar terms) from 3.4 percent in 2002. The most important driving force was the increased flow of credit to the private sector, equivalent to 6¾ percent of GDP in 2003, compared to 4 percent of GDP in 2002, while the percent minimum wage increase on January 1, 2003 (over 25 percent in real terms) and delayed energy price adjustments together raised the current account deficit relative to GDP by about 1 percentage point.

C. Fiscal Policy

14. A turnaround in fiscal policy performance began in 1999 in response to severe balance of payment problems (Figure 4). A large upfront-adjustment in 1999, primarily based on revenue measures, reduced the deficit of the general government to 3.6 percent of GDP from 5.4 percent of GDP in 1998, but fiscal consolidation was interrupted by an election-related spending spree in late 2000 and early 2001. In the negotiations on the latest SBA in 2001, the authorities agreed that further fiscal consolidation was required to reduce inflation and contain the current account deficit, but insisted on a gradual approach to facilitate improvements in the social safety net and an increase in capital spending. Consequently, while the deficit of the general government relative to GDP declined from 4 percent in 2000 to 2.3 percent in 2003, this largely reflected a decline in interest expenditure by 2.7 percentage points owing to progress in disinflation and renewed access to international capital markets. At the same time, primary expenditure relative to GDP rose by 0.8 percentage points, with the largest share (0.6 percentage points) being used for an increase in capital spending. Public sector debt (including publicly guaranteed debt) remains relatively low at 26 percent of GDP at end-2003.

Figure 4.
Figure 4.

Consolidated General Government

(in percent of GDP)

Citation: IMF Staff Country Reports 2004, 113; 10.5089/9781451832747.002.A001

15. Major progress was made under the recent SBA in reforming the tax system and improving revenue administration. In 2002, the authorities implemented a comprehensive VAT and profit tax reform that eliminated several distortionary tax incentives that had adversely affected revenue performance and clouded the investment climate. Moreover, following a period of excessive increases in social security taxes, which created strong incentives for shifting labor to the informal economy, contribution rates were cut by a cumulative 10.5 percentage points between 2001–04. Furthermore, the authorities have started implementing comprehensive tax administration reform.

16. The authorities have recently strengthened the social safety net. The authorities introduced a minimum income guarantee scheme in January 2002. In 2003, to mitigate the social impact of energy price increases and privatization, they improved the scheme for heating-related transfers to low-income households and introduced and a generous “supplementary income scheme” for employees laid off by large SOEs.

D. Monetary Policy and Banking

17. The authorities chose a gradual disinflation strategy. In the face of rigid collective labor contracts and powerful trade unions, the authorities were not confident that they could enforce a restrictive wage policy stance in SOEs. Indeed, failure to implement an effective incomes policy and a more aggressive stance to reduce the consolidated public sector deficit were the key obstacles to controlling inflation and explain why inflation in Romania has been considerably higher compared with other transition economies. Over the last three years, relying on the exchange rate as a soft nominal anchor, the NBR has guided the exchange rate broadly in line with the disinflation target and the scope for real effective appreciation resulting from the productivity growth differential. The existing restrictions on non-resident purchases of T-bills and deposits with local banks have afforded the NBR a degree of autonomy in setting its policy interest rate, used mainly for supporting the desired exchange rate dynamics and reserve accumulation. This monetary framework successfully anchored inflation expectations by avoiding large and disruptive fluctuations in the exchange rate. At the same time, the steady, if gradual, disinflation path preserved competitiveness by avoiding unsustainably large and rapid real exchange rate appreciation. Dollarization of bank assets and liabilities 3, while still substantial, is less of a problem than in many neighboring countries and does not, at present, constrain the NBR’s exchange rate policy.

18. Recent experience has shown, however, that this framework can create tensions with the choice between inflation and external objectives. In both early and late 2003, emerging net outflows created a dilemma between adhering to disinflation targets by supporting the targeted exchange rate path or observing the NFA targets. As disinflation is the NBR’s primary objective, the Bank both times resolved this dilemma in favor of the former. This choice was facilitated by the comfortable reserve level and the expected temporary nature of the outflows (a judgment vindicated ex post).

19. The soundness of the banking system has improved significantly. The 1997–1999 banking crisis led to discontinuation of the use of state-owned banks for directing lending and financing quasi-fiscal losses. In its aftermath, banks have been restructured and many of them privatized. Currently, out of 30 banks, only three remain in state hands, and foreign banks control more than half the assets in the banking system. The crisis left its scars on financial intermediation: despite recent rapid growth, credit to the non-government sector— about 16½ percent of GDP—still remains low by international standards. The 2003 FSAP found that banks are well-capitalized and liquid, even though the reported high capital adequacy ratios may be somewhat overestimated because of problems with the valuation of fixed assets.

E. Structural Reforms

20. Throughout the transition, losses from quasi-fiscal activities were a major source of macroeconomic instability, but efforts to reduce these losses started in earnest only in the second half of the 1990s. During 1996–2000, about four percent of GDP in quasi-fiscal operations—in the form of implicit exchange rate subsidies and subsidized lending to the agriculture sector in the form of directed lending—were curtailed and, to a relatively small extent, replaced by budgetary subsidies. However, depressed energy prices continued to be used to subsidize unviable energy-intensive industrial users.

21. Sharp increases in energy prices under the recent SBA have reduced energy sector losses substantially. Breaking with the tradition of depressed energy prices, the authorities have since 2001 brought electricity prices close to cost-recovery levels, sharply increased heating prices and raised domestic gas prices, though the latter remain substantially below import parity. Estimated energy sector losses (including implicit subsidies) fell from 4.7 percent of GDP in 2000 to 2.5 percent of GDP in 2002, but rose to 2.8 percent of GDP in 2003 owing to delayed price adjustments (Text Table 1).

Text Table 1.

Estimated Losses From Quasi-Fiscal Activities in the Energy Sector 1/

(In percent of GDP)

article image

Including losses resulting from payment arrears from non-collection.

Staff projection

Predominantly implicit subsidies resulting from pricing below import parity.

Cash losses resulting from pricing below cost-recovery levels.

22. The fight against the non-payment culture in the energy sector has been partially successful. In the electricity and gas distribution sectors, utility bill collection rates have risen significantly and reached levels similar to those in industrial countries, reflecting an aggressive use of conditionality to enforce the disconnection of nonpayers under the recent SBA. However, the wholesale electricity collection rate, while improved, remains problematic. In the heating sector, collection rates have risen only marginally, largely reflecting the absence of a credible restructuring strategy for this sector. Such a strategy would need to comprise the conclusion of delivery contracts with individual households and their metering, the closure of unviable plants, and the modernization of economically viable plants.

23. Arrears to the budget have been persistent, thus undermining an efficient allocation of resources and creating an un-level playing field among enterprises. Four factors account for the continued prevalence of arrears. First, the authorities have tolerated arrears from well connected private sector companies and socially sensitive SOEs such as the railways and mines. Second, tax administration has been weak since until very recently. Third, the budgets of public enterprises are often approved with little attempt to ensure that the enterprise concerned will be able to pay its budgetary obligations. Fourth, as noted above, the culture of offsets of obligations means that companies often have little incentive to pay. Recent data show that the stock of tax arrears of the monitored SOEs (excluding accrued interest and penalties) increased by ½ percentage point of GDP between mid-2002 and mid-2003. The increase in arrears was particularly pronounced in the mining and railway sectors, for which long-overdue restructuring measures have been repeatedly postponed. Moreover, the arrears of a number of large private companies have surged, particularly in the refinery sector. On the positive side, the electricity and gas distribution companies were able to repay their tax arrears by September 2003.

24. Indiscipline in wage policy has repeatedly threatened stabilization efforts. Two areas were critical. First, wages in SOEs persistently exceeded agreed norms, primarily reflecting the lack of determination on the part of the line-ministries to enforce the approved wage budgets. As a result, performance criteria were repeatedly breached, resulting in delays in completing reviews. Second, yielding to pressures from trade unions in June 2002, the government unexpectedly agreed to a 43 percent minimum wage hike from January 2003, thereby contributing to the surge in the current account deficit and preventing more rapid disinflation in 2003.

25. Privatization fell continuously short of program targets, but picked up in 2003. Faster privatization of enterprises in the portfolio of the Privatization Agency, primarily comprising industrial SOEs outside the energy sector, was initially impeded by the requirements that investors provide guarantees to preserve employment and make sizeable investments. In 2003, the authorities implemented a large-scale voluntary employment reduction program, which facilitated the privatization of some large loss-makers. Outside of the banking and energy sectors, the government has privatized 35 large companies with over 112,000 employees since 2001, in many cases involving substantial employment reductions (Figure 5). Generous severance payments for laid-off workers and write-offs of liabilities have facilitated the privatization process considerably. However, in the energy sector, the Ministry of Economy and Commerce has moved slowly in starting several important privatization projects, reflecting its reluctance to give up influence in this sector. Recently, some major privatization projects have experienced significant delays, including the integrated oil company Petrom, the largest company in the country, owing to investors’ request to have more time for due diligence, unresolved legal issues of land ownership, and the authorities’ subdued enthusiasm. Delays also occurred for the privatization of two electricity generation facilities and the two gas distribution companies.

Figure 5.
Figure 5.

Total Employment in 86 Monitored SOEs

(1000 persons)

Citation: IMF Staff Country Reports 2004, 113; 10.5089/9781451832747.002.A001

26. Despite recent improvements, the business environment has remained mixed. Foreign investors have welcomed the more stable macroeconomic environment and the tax legislation overhaul under the recent SBA. However, progress in improving governance, eliminating corruption, and increasing transparency has been insufficient, and enforcement of laws by the judiciary has remained weak. Employers associations have raised concerns about the new labor code, which has imposed undue impediments to layoffs.

III. Nature and Reasons for the Fund’s Long-term Engagement

27. The Fund’s engagement with Romania has indeed been extensive. Since the start of the transition, Romania had six (non-precautionary) SBAs, three of which were extended.4 As all but the last program eventually went off-track, access under these arrangements was not fully disbursed. As a result, there has not been a prolonged period of high Fund exposure. After peaking at 120 percent of quota in 1994, outstanding use of Fund credit now stands at around 40 percent of quota (Figure 6).

Figure 6.
Figure 6.

Romania: Engagement with the Fund, 1991-2003

Citation: IMF Staff Country Reports 2004, 113; 10.5089/9781451832747.002.A001

28. The Fund’s long-term engagement in Romania reflects two main factors:

  • Romania’s large structural reform agenda: Owing to the particularly unfavorable starting conditions at the beginning of the 1990s, a lengthy transition was unavoidable.5

  • The slow pace of reforms and repeated reversals of macroeconomic stabilization efforts: Largely reflecting a lack of ownership of sustained reform efforts, macroeconomic policies throughout the decade alternated dramatically between periods of tightening and relaxation.

29. There are a number of reasons why the Fund repeatedly re-engaged with Romania in a program context:

  • Balance of payments pressures: In most cases, Fund approval of new arrangements was a response to severe immediate pressures on Romania’s balance of payments.

  • Strong program design: Successive programs targeted strong adjustment and structural problems that remained unresolved from preceding programs.

  • Progress in policy and reform implementation: Progress was notable around the approval of each program, with heavy reliance on prior actions. However, with mixed ownership of reforms, program implementation often weakened during the program period, particularly after immediate macroeconomic pressures had subsided.

  • Support for reforms and stabilization policies: In addition to external financing, successive governments were interested in Fund programs to boost their policy credibility. Moreover, reform-oriented factions within the government saw program engagement as the best means of furthering their economic policy objectives.

30. The performance under the three SBAs between 1991–96 raises questions about the appropriateness of the composition of conditionality under these three arrangements. While the build up of major macroeconomic imbalances and the slow pace of structural reforms during this period primarily reflected the authorities’ insufficient ownership of the stabilization and reform programs, it also raises the question why it took the Fund until 1997 to recognize that re-engaging with Romania in a program relationship would need to address the issue of vested interests through front-loaded structural conditionality. It can be argued that the emphasis on macro-based conditionality in Fund-supported programs postponed the emergence of sustained growth.

31. While conditionality appears to have been generally appropriate under the last three SBAs, a few shortcomings could have been addressed earlier. The comprehensive reliance on structural conditionality proved effective in addressing the resistance of vested interests against structural reform. However, given the risks emanating from quasi-fiscal activities, efforts to measure losses resulting from these activities should have started earlier. Moreover, while the last SBA brought about major progress in improving the utilities’ collection rates in the electricity and gas sectors, collections in the ailing district heating sector hardly improved, reflecting the absence of a strategy for reforming this sector.

32. The potential drawbacks of longer-term engagement were mitigated by the Fund’s requirement of a positive track record prior to the approval of a new program. While the Fund showed flexibility by re-engaging with Romania despite uneven performance, the bar for such re-engagement was set sufficiently high to preserve the credibility of its program signals and limit the development of expectations that Fund program support was automatic (Table 1). The Fund’s strategy to advance reform was to place conditions for re-engagement on deep-seated structural measures that would be difficult to reverse, in particular in the areas of bank restructuring and enterprise privatization. For this purpose, given the authorities’ mixed ownership, the use of comprehensive structural conditionality, particularly prior actions, was effective in moving reforms forward.

Table 1.

Romania: Conditionality under the last three SBAs

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Source: IMF Staff Reports.

33. The Fund’s determination not to accommodate major policy slippages that could have derailed macroeconomic stabilization also contributed to preserving its credibility. With the exception of the last SBA, programs went off-track by margins too great to be reasonably accommodated. Accordingly, many reviews were never completed. This likely helped maintain frankness in Article IV consultations, many of which were completed when program negotiations had stalled. Under the most recent SBA, Fund staff did recommend approval of multiple waivers largely on account of the overall good macroeconomic performance, especially when compared to earlier programs. The granting of multiple waivers also reflected the fact that some of the structural conditionality was difficult, involving action among many different agencies and institutions. At the same time, it is worth noting that granting multiple waivers may have lessened the authorities’ resolve to implement their commitments under the program.

34. Progress towards a market-based and financially stable economy gradually increased under the last three SBAs. The comprehensive use of structural conditionality, in particular prior actions, under the last three SBAs, and more recently, the authorities’ commitment to join the EU in 2007 have tangibly increased the “delivery rate” of policy measures that were agreed under the last three SBAs.

35. The Fund’s Private-Sector-Involvement Initiative (PSI) in 1999 strained relations with the authorities. In the aftermath of a $750 million bond repayment in mid-1999, the Fund did not wish to provide financial support and thereby appear to bail out (ex post) the private creditors, which would have undermined the credibility of the PSI initiative. In the context of the 1999 SBA, the Fund required Romania to secure new money from private creditors as a condition for approval of the arrangement and subsequent completion of reviews. Taking into account Romania’s circumstances, the Fund accepted the authorities’ assurances that they would be able to secure new money from various private creditors as a basis for approving the SBA in August 1999, even though the staff had concerns about the feasibility of this new borrowing. In the event, the authorities found it difficult to secure but a small proportion of the required new private money and complained that they were effectively forced to borrow on unfavorable terms. They also noted that their efforts to borrow were undermined by the Fund’s inclusion of Romania as a case on which to pursue PSI alongside countries that could have been illiquid or insolvent. In the context of a strengthening balance of payments and recognizing the problems with the PSI, the Fund gradually eased and eventually dropped the borrowing requirement.

IV. Lessons and Challenges Going Forward

A. Program Ownership

36. Several political and institutional factors set the stage for improved performance under the recent SBA. These factors include: (i) the government’s strong commitment to joining the EU; (ii) political stability and the comfortable majority in Parliament, which ensured smooth passage of the budgets and the comprehensive tax reform; and (iii) previous stabilization and reform efforts, which, despite their shortcomings, created more propitious conditions for further reforms.

37. Nevertheless, policy ownership remained mixed, reflecting the contradiction between the government’s strong commitment to EU accession and its temptation to give in to populist pressures. This tension was characteristic of the authorities’ commitment to various components of the program:

  • On the one hand, fiscal and monetary policies were on track. Reflecting the unambiguous commitment of the Minister of Public Finance and the NBR to sustain the recent gains in macroeconomic stabilization, policy implementation in these two core areas of the Fund’s expertise was generally strong.

  • On the other hand, the authorities’ commitment in the areas of wage policy and structural reforms remained weak, largely reflecting resistance from vested interests. The collusion between the management of large SOEs, labor unions, and factions within the ruling parties has frequently hampered efforts to impose financial discipline on SOEs and accelerate privatization. In this context, concerns about the social impact of restructuring and privatization have been used by vested interest to defend keeping unviable SOEs afloat, while efforts to render the social safety net compatible with accelerated structural reforms have started only recently.

38. Policy coordination within the government has not been sufficiently strong to overcome ownership problems. The absence of a clear intra-governmental consensus on key economic policy parameters has weakened the line-ministries’ resolve to ensure timely and full implementation of agreed measures. While the Prime Minister often intervened in such inter-ministerial differences to keep the program on track, valuable time was lost, and program reviews had to be postponed repeatedly.

39. In the course of 2003 the authorities gradually recognized that stepping up reform efforts is imperative for keeping EU accession on track. Even though the authorities have always acknowledged that EU accession requires accelerating privatization and SOE restructuring, the inclination to translate this agenda into ambitious front-loaded action plans has remained weak. However, the EU Commission’s decision in November 2003 not to grant Romania the status of a fully-functioning market economy and the still substantial number of EU-negotiation chapters that need to be closed by end-2004 (8 out of 30) gave rise to fears that Romania might run out of time. As a result, EU accession has become an important anchor of the political process. Nevertheless, it remains to be seen whether the authorities’ resolve to sustain the recent macro-stabilization and continue with structural reforms will prevail in the run up to the parliamentary and presidential elections scheduled for November 28, 2004.

B. Bank-Fund Cooperation

40. The overlap between Bank and Fund conditionality has been substantial, reflecting Romania’s extensive quasi-fiscal activities, unfinished structural reform agenda, and the authorities’ mixed ownership. The Bank has taken the lead in the policy dialogue with the authorities on several structural reforms, including privatization, private sector development, poverty reduction, institution building, and governance (Text Table 2). The Fund has, however, played a major role in structural reforms with important fiscal and quasi-fiscal implications. When structural reforms have lagged in areas with a significant macroeconomic impact, Fund program targets have been difficult to reach and have led to a tendency for the Fund to introduce structural conditions of its own.

Text Table 2.

The Bank’s Recent Adjustment Programs in Romania

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41. While the overlap between Bank and Fund conditionality in the area of structural reforms was not conducive to reducing the number of conditions in the Fund program, it helped increase the pressure on the authorities to maintain the reform momentum. Given the government’s reluctance to proceed with long-overdue structural reforms, the involvement of both the Bank and the Fund in some key structural measures (e.g., the closure of Bancorex, the privatization of large SOEs, and energy sector reforms) was essential for their success.

42. Bank-Fund cooperation was generally close, and the Bank’s technical expertise was a key input for the design of Fund programs. The Fund relied to a significant extent on the comprehensive technical work of Bank experts, in particular in the areas of energy sector reforms and privatization. Fund staff consulted with the Bank on measures to be included in the Fund’s structural conditionality and invited Bank staff to participate in relevant Fund missions. This approach has proven successful in improving the collection rates in the electricity and gas sectors and setting energy prices at a level that would attract further investment.

43. Collaboration has been most effective when it has started early in the program preparation cycle and when areas of separate and joint intervention have been clearly defined from the outset. If areas outside the Fund’s core competencies are key for achieving the targets under Fund programs, an early involvement of the Bank during the program preparation is imperative. While this principle was generally adhered to in designing the recent SBA, there were areas in which an earlier and more systematic involvement of the Bank would have improved the prospects for meeting the program targets. For example, it is questionable whether, in the absence of a comprehensive medium-term strategy for reforming the ailing district heating system, there was ever a reasonable chance of meeting the collection rate targets.

44. Bank-Fund consultation should also extend to structural reforms where implementation exceeds the duration of Fund programs. There has been a tendency for the Fund to focus on reform measures that stood a chance of being implemented in the relatively short duration of the respective SBA. This approach has at times diverted attention from structural reforms that can only be addressed over a longer-term horizon. For example, had efforts to use the Bank’s expertise for designing medium-term strategies for reforming the large loss-making sectors of mining and railway transportation been initiated earlier, the substantial pick up in these sectors’ quasi-fiscal losses in 2003 might have been avoided. The benefits of developing such medium-term sectoral strategies can be expected to outweigh potential delays during the program preparation stage.

45. While the Bank and the Fund always agreed on the direction of reforms, reaching consensus on their timing and details required at times significant efforts. For example, with respect to privatization schedules for competitive international tenders, the Fund often favored tighter deadlines for intermediate steps in the interest of expediting the process, while the Bank emphasized that a close scheduling of large privatization deals with a limited number of potential buyers might reduce the likelihood of successful outcomes. This might in part reflect the different design of the two institutions’ conditionality, with time-bound quarterly reviews under the Fund’s SBAs contrasting with floating decision points for the disbursement of PSAL 1 and 2 tranches.

46. Joint Bank-Fund communications with the authorities have contributed to successful policy dialogue. In addition to enhancing policy leverage, it gives the authorities comfort that the requirements of the IFI programs are consistent with each other and reduces the scope for strategic delay. Joint communications have been used effectively, inter alia, on gas pricing, labor code amendments, and the reform strategy for the mining sector.

C. Key Challenges

47. In the period ahead, the two key challenges facing the authorities are how to sustain macroeconomic stabilization and maintain the momentum of structural reforms over the election cycle and in the run-up to EU accession:

  • While the macroeconomic environment has improved markedly, inflation still has some way to go before settling in single digits and efforts to contain the current account deficit have to be stepped up.

  • Completing structural reforms will be key for keeping EU accession on track and maintaining high growth.

Sustaining Macroeconomic Stabilization

48. Major efforts are needed to ensure further disinflation to EU levels. Experience in other EU accession countries shows that the transition to single-digit inflation is difficult. Achieving the authorities’ inflation targets of 9 percent by end-2004 and 4 percent by end-2007 will require further fiscal consolidation, prudent monetary and exchange rate policy, including measures to constrain rapid credit growth, and tighter incomes policy entailing low minimum wage increases and significantly improved wage discipline in SOEs.

49. To contribute to reducing inflation and the current account deficit, further fiscal consolidation is required. With public and foreign debt-to-GDP ratios at moderate levels, the main consideration for the medium-term fiscal stance is the need to contribute to disinflation and contain the external current account deficit below a level that would raise market concerns. As the private savings-investment balance is expected to continue to deteriorate with strong consumption and investment, public sector savings will have to provide an offset, in the form of both lower budget deficits and stronger SOE finances. This offset will have to be sufficiently strong to compensate for the impact of the credit boom on the private savings-investment balance.

Continuing Structural Fiscal Reforms

50. The authorities should address the remaining weaknesses in the tax system and implement the second phase of the tax administration reform. While the recent VAT and profit tax reform eliminated several major distortionary tax incentives, some exemptions remain embedded in, inter alia, special legislation for industrial parks, free zones, and disadvantaged areas. These should be carefully reviewed with a view to establish a schedule for their elimination. Moreover, building on recent major institutional changes, substantial further efforts are required to modernize systems and operations of the newly established revenue administration. At the same time, the authorities will need to create a forceful precedent for their seriousness in addressing the culture of nonpayment of taxes by, inter alia, initiating bankruptcy procedures against large public and private debtors.

51. While the pension fund to date has not incurred large deficits, further reforms are crucial for ensuring its long-term sustainability. Despite a high and rising dependency ratio, the deficit of the pension fund has been contained below 1 percent of GDP over the last few years, largely reflecting a relatively low and declining replacement ratio. Looking forward, however, several factors are putting at risk the sustainability of the public pension system: (a) the authorities envisage further cuts in social security contribution rates which, even after the latest cuts, still amount to 49.5 percent of gross wages; (b) given the already modest level of the replacement ratio, the scope for using a further decline in this ratio to compensate for declining revenue appears to be very limited; (c) the dependency ratio will increase further, as employment growth is projected to fall short of the increase in the number of retirees, with the old-age dependency ratio forecasted to double over the next 40 years. Against this background, further measures are required to ensure the financial viability of the public pension system, in particular by broadening the social security tax base, accelerating the increase in the retirement age, and equalizing the retirement age for men and women, as recommended by the World Bank.

52. The role of Romania’s Pre-accession Economic Programmes (PEPs) for the medium-term fiscal framework should be strengthened. While both the PEPs and the budgets submitted to Parliament provide a three-year forecast horizon, both documents have often been inconsistent and have undergone frequent revisions, thereby undermining their utility for medium-term policy analysis and design. Increasing the consistency and credibility of the medium-term fiscal framework would help internalize long-term implications of expenditure programs and prioritize spending priorities. To enhance the credibility of the medium-term framework and build ownership, the authorities could consider establishing an autonomous agency for assessing medium- and long-term fiscal risks emanating from the envisaged large-scale use of off-budget guarantees and Public-Private Partnerships (PPPs), the sustainability of the pension fund, and contingent liabilities in the banking sector.

Monetary Policy and Banking Supervision

53. The NBR will need to manage the transition to a new monetary policy framework. The current exchange-rate-based framework with multiple, but prioritized objectives is expected to stay in place until inflation settles in single digits. The success of the current framework depends on maintaining restrictions on short-term capital inflows. While such restrictions have their merits until low inflation is firmly entrenched, they will have to be relaxed in the medium term to reap the full benefits from integrating into the international financial system and to comply with EU requirements. Changes in the NBR Law are needed to guarantee the primacy of the inflation target, as well as the operational independence of the central bank in line with Maastricht criteria. In addition, given the close correlation between wage inertia and inflation inertia in Romania, a strict incomes policy needs to complement monetary policy to achieve single-digit inflation. The authorities are planning to adopt a flexible form of inflation targeting to succeed the current monetary framework. As the exchange rate pass-through to prices still dominates the effect of interest rate changes on inflation, the exchange rate would continue to be used as an implicit nominal anchor in the beginning of the gradual transition to the new regime. Further progress in understanding the monetary transmission mechanism and developing effective monetary instruments and forecasting techniques is required before inflation targeting can be considered a viable option.

54. On the prudential side, the NBR needs to find the most effective instruments in managing the financial system. While the low degree of financial intermediation calls for sustained high credit growth in the medium term, the current rapid expansion, targeted primarily at households, is overstimulating domestic demand and raising concerns over the resilience of the credit portfolio to macroeconomic shocks. In particular, sharp exchange rate depreciation and/or a slowdown in growth may impair borrowers’ ability to pay and thus lead to bank losses. Close monitoring and enhancing supervision through strengthened risk assessment, as well as adopting more conservative supervisory and regulatory practices in some areas, particularly consumer loans and weak banks are imperative.

Completing the Structural Reform Agenda and Improving the Business Climate

55. Completing the task of stabilization crucially hinges on progress in privatization and imposing hard budget constraints in the state-owned enterprise sector. The main challenges in this respect are:

  • Privatization needs to proceed expeditiously. Despite improved performance in 2003 in privatizing large SOEs under the privatization authority, further reducing the size of the still large state sector is imperative. While the authorities’ intention to finalize the privatization of the SOEs that remain in the portfolio of the privatization authority by end-2004 is laudable, privatization in the energy sector, which is characterized by particularly poor governance, will need to accelerate, with the sale of Petrom being the litmus test for the authorities’ reform ownership in this area. In the banking sector, privatization should be completed by selling BCR, the largest bank in the country, and CEC, the savings bank, to strategic investors as soon as possible. Given the continued macroeconomic relevance of quasi-fiscal activities, including strong structural conditionality on privatization in a possible successor arrangement with the Fund would be imperative.

  • Efforts to eliminate losses from quasi-fiscal activities, particularly in the energy sector, need to continue. The momentum in fighting the nonpayment of utility bills needs to be maintained, while further increases of gas prices to the import parity level, as well as timely adjustments of electricity and heating prices in line with costs are required. Eliminating quasi-fiscal losses also requires the closure of unviable industrial consumers with large arrears to the budget and utilities. Moreover, developing a medium-term strategy for the district heating system is long overdue. Given the macroeconomic risks emanating from quasi-fiscal activities and the key role of conditionality in this area under the recent SBA, it is surprising that efforts to implement a reliable accounting framework for measuring the broad public sector deficit have started only recently. To mitigate the social impact of structural reforms, the existing social safety will need to be further strengthened, in particular by improving the administrative capacity and broadening the coverage of the minimum income guarantee scheme.

56. Stepping up efforts to improve governance and the business environment is crucial for sustaining robust economic growth. A revision of the labor code is crucial for maintaining unemployment at the relatively low current level during the ongoing restructuring of the SOE sector. Major progress in improving governance is needed, building on the work of the recently created anti-corruption authority. As weaknesses in governance remain a major barrier to generating sustained private sector growth and attracting FDI, stepping up the fight against corruption and the reform of the judiciary remain top priorities on the agenda of institutional reforms to improve the business climate. The last SBA addressed governance issues implicitly by promoting legislative changes in core areas of the Fund’s competencies, inter alia by eliminating distortionary tax incentives and aligning banking supervision with Basel standards. However, given that weak governance continues to be a major impediment for faster progress in structural reforms and sustained robust growth, the Fund would be well advised to broaden its approach by seeking agreement on initiatives in areas related to its own core competencies as well as by supporting core components of the World Bank’s conditionality:

  • The recently established anti-corruption office should step up the fight against corruption, including (a) in the tax and customs administrations; and (b) with respect to recent cases of non-transparent privatization and public procurement.

  • The independence of the energy sector regulators needs to be strengthened to ensure their de facto autonomy. This could be achieved by establishing the requirement (a) for the presidents of these agencies to be appointed for seven years (rather than four years); and (b) for the agency budgets to be approved by parliament (rather than by the government) for a multi-year period.

  • Transparency in the SOEs’ accounting system needs to be improved, inter alia, (a) by ensuring full compliance with IAS and requiring for all energy sector companies auditing through internationally recognized auditing companies; and (b) by establishing an obligation for the government to submit to parliament, together with the draft budget, a report on quasi-fiscal activities, tax subsidies to SOEs, and envisaged measures to reduce losses from quasi-fiscal activities.

  • The Fund should insist on amendments (a) to the Law on the Declaration of Assets which, in its current form, is insufficient for containing corruption; and (b) to legislation allowing for the “extraordinary appeal” by the Prosecutor General, which has been identified by the World Bank as a major impediment to the independence of the judiciary. The Bank has conditions in its PAL program on both issues and has indicated that supportive actions under the Fund’s SBA would be helpful provided the terms and timing of respective conditionality are closely coordinated.

V. Strategy for Future Fund Engagement

57. The progress achieved under past programs would make a surveillance-based relationship feasible now. Romania achieved major progress in macroeconomic stabilization, regained international market access, and does not have an imminent balance of payments need. It would be possible for further reforms to be completed outside of an arrangement with the Fund as in other transition economies.

58. However, the authorities see further Fund engagement as crucial for keeping EU accession on track and reducing balance of payments vulnerabilities and thus have requested a new SBA, which they intend to treat as precautionary. Reform-oriented factions within the ruling party continue to consider program conditionality as a commitment mechanism to enhance credibility, particularly during a year that is key for ensuring the next steps toward EU accession.

59. The request for a new arrangement could be supported if it provides assurances that (a) macroeconomic stabilization will be sustained; and (b) vigorous structural reforms will continue.

  • The recent surge in the current account deficit indicates that balance of payments vulnerabilities still exist. A new arrangement would mitigate these vulnerabilities by addressing the causes of the deterioration in the current account. The key instruments for achieving this objective would be a reduction in the public sector deficit combined with measures to contain the excessive credit growth and wages in the SOE sector. A new program could also be instrumental in ensuring sufficient credibility of macroeconomic policies that is a prerequisite for achieving single-digit inflation.

  • A new SBA may strengthen the momentum of structural reforms during the run up to the elections. By contributing to giving shape and content to macroeconomic policies and structural reform, it may also help keep EU accession on track.

  • Good performance under one more program would provide a favorable opportunity to exit program engagement on a positive note and to establish a strong track record outside the context of a Fund program, thereby enhancing policy and institutional credibility.

  • A successor arrangement should be a low access precautionary SBA given the absence of an imminent financing need. The precautionary nature also better corresponds with the transition to a surveillance-only relationship. Moreover, to ensure the implementation of those structural reforms that are key components of an exit strategy, a somewhat longer program period, say 24 months, would be preferable.

  • However, a surveillance-only relationship would be preferable if agreement on a strong program cannot be reached.

60. Elements of a new arrangement should comprise:

  • Explicit exit strategy: To guard against the risk that there is an automatic move from one program to the next, an explicit strategy for exiting from Fund program-engagement should be formulated and made public. Developing the institutional capacity for effectively addressing the remaining structural reform agenda and building a broad political consensus in favor of such a strategy is a prerequisite for EU accession. In this process, the role of Fund programs as a commitment mechanism that partially substitutes for full reform ownership is evaporating.

  • A strong and front-loaded structural reform component: The next Article IV report or program document should specify the key structural reforms, the completion of which is critical to medium-term external viability.

  • Early coordination with the World Bank: These critical reforms should be coordinated and agreed with the World Bank early on, to ensure a unified front vis-à-vis the authorities, and to allow the Bank to prepare for supporting implementation.

  • Maintain focus on structural conditionality: Given the importance of structural reform for medium-term external viability and the low probability that reform ownership will strengthen in the run up to the elections, there is limited scope for streamlining conditionality in a future program.

  • Continued readiness to use strong prior actions: As in past programs, the Fund should continue to exploit the effectiveness of conditioning new arrangements and reviews on the prior completion of significant structural reforms.

  • Prepare public perceptions: An external relations policy under a successor program that helps to prepare public perceptions for the graduation to a surveillancebased relationship may help to reduce the risk that the end of program engagement is interpreted as a negative signal.

VI. Reaction of the Authorities

61. The authorities thought the report was generally balanced and realistic, and saw it as important to the transparent cooperation between Romania and the Fund. They thought, however, that some issues warranted more emphasis or greater discussion of their context. On general issues, they noted:

  • Three factors explained why the transition process in Romania took so long (para. 2-10). First, as emphasized in the EPA, the starting point differed significantly from that in other transition economies. Structural problems were deep-rooted, and social concerns played a prominent role. Attempts to speed up economic reform would have triggered large social disturbances. Second, shock therapy was not a viable option since Romania had just emerged from the shock of harsh austerity linked to the early repayment of Romania’s external debt during the Ceausescu era. The deliberate decision to adopt a gradual approach to reform in the 1990s inadvertently resulted in a lack of decision and a piecemeal approach. Third, some approaches to reform were wrong but were corrected. Two specific examples were noted:

    • article image
      Under the first three SBAs, the coordination between the Fund, the World Bank, and the authorities on structural reforms was weak, and Fund conditionality did not sufficiently address the structural reform agenda. This coordination failure also contributed to the stop-and-go policies characteristic for the 1990s.

    • article image
      The Fund’s PSI initiative confused a liquidity crisis for a solvency crisis in Romania and cut off Romania’s market access at a critical juncture (para. 35). The authorities had to struggle to regain unduly lost credibility.

  • The authorities reiterated the current government’s commitment to reform, reflected in the strong measures taken in the last three years and the successful completion of the most recent Stand-By Arrangement (para. 36-39). In this regard, improved coordination of economic policies between the authorities, the Fund, and the World Bank was instrumental in the positive achievements (para. 40-46).

62. On the forward-looking aspects of the report, the authorities agreed that a relatively long program period would be appropriate in a new arrangement with the Fund in order to ensure the implementation of the large structural reform agenda (para. 59). Successful completion of such a program should pave the way to graduation from future use of Fund resources (para. 60).

63. In response to specific assessments in the report, they made a number of observations:

  • The authorities defended their decision to adopt a gradual disinflation strategy (para. 17), arguing that a more ambitious approach was not feasible owing to social and structural reasons. They also underlined that disinflation should not be achieved at the expense of growth.

  • The authorities thought the assessment understated progress in energy sector reform (para. 21-22). They referred to numerous technical restructuring measures implemented during 2001-2003. With respect to the heating sector, they noted that a strategy will be drafted with World Bank support, and two PHARE projects are being implemented (para. 22 and 55).

  • Regarding the assessment that public enterprise arrears to the budget have been persistent, giving these companies an unfair advantage over competitors (para. 23), the authorities noted that APAPS improved financial and wage discipline in the companies under its authority, and the related performance benchmarks under the IMF program were largely met. On the criticism that repeated postponements of the mining sector reform contributed to the increase in arrears, they noted that reform in this sector has been particularly challenging because it was oversized at the beginning of transition, and many mining activities are in isolated areas with few attractions to new investment.

  • The authorities held the view that the report understates what has been achieved in privatization over the last three years (para. 25). Since the beginning of 2001 APAPS has sold 1½ times as much share capital as in the previous 8 years. Moreover, this privatization targeted the “tough core of the Romanian economy,” which had resisted privatization/restructuring attempts for more than 10 years. The authorities stated that conditions on preserving employment or making investment were not imposed in the sale offers of public enterprises, nor were they considered to be compulsory in selecting the winning bids. They emphasized that privatization is also underway in the energy sector though there are delays and difficulties, mainly due to the unfavorable international environment in the sector.

  • Reacting to the claim that an efficient exit mechanism for unviable state-owned and private companies remains to be established (para. 50 and 55), the authorities stated that Romania has a number of mechanisms to address unviable companies including through voluntary liquidation, judicial reorganization, and bankruptcy procedures. Some state-owned enterprises were restructured to prepare them for privatization.

  • Commenting on the Fund’s use of conditions on deadlines for intermediate steps in the privatization process (para. 45), the authorities noted that such conditions put adverse pressure on the government and work in favor of potential investors, especially when the number of potential investors is limited.

  • They disagreed with the assessment that the independence of the energy sector regulators needs to be strengthened (para. 56), stating that the gas and electricity regulators are autonomous agencies, not financed from the budget, with the power to establish prices according to their own methodologies. In this context, they noted that the gas price regulator has already announced the implementation of the new price-cap pricing mechanism starting in 2005.

  • Regarding the assessment that the elimination of the “extraordinary appeal” of the Prosecutor General is a key component of the judiciary reform (para. 56), the authorities noted that the “extraordinary appeal” procedure has already been eliminated for civil and commercial verdicts, and its elimination for penal verdicts is currently being drafted.


The team comprised E. van der Mensbrugghe (Head), A. Westphal, N. Gueorguiev, A. Tieman (all EUR), W. Brown (PDR), S. Danninger (FAD), and R. Hood (IBRD).


For a detailed discussion of the earlier programs see Staff Report for the 1997 Article IV Consultation and Request for Stand-By Arrangement (4/9/1997).


As of late 2003, about 56 percent of bank loans and 46 percent of deposits were denominated in foreign currencies.


New arrangements were approved in 1991, 1992, 1994, 1997, 1999, 2001, and extensions in 1995, 2000, and 2003.


This was recognized early on. At the 1992 Article IV consultation “Directors noted that the transformation of the Romanian economy into a functioning market economy would necessarily be a lengthy process. Success would require perseverance in domestic policies as well as substantial financial assistance from abroad for an extended period.” (6/5/1992)

Romania: Ex-Post Assessment of Longer-Term Program Engagement
Author: International Monetary Fund