Romania—Staff Report for the 2010 Article IV Consultation, Fourth Review Under the Stand-By Arrangement, and Requests for Modification and Waivers of Nonobservance of Performance Criteria – Supplementary Information, and Supplementary Letter of Intent
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International Monetary Fund
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Publication Date:
26 Jul 2010
eISBN:
9781455203468
Language:
English
Keywords:
ISCR; CR; government; disbursement of SDR; GDP deflator; real GDP; Romania's request; SDR; sustainability framework; debt ratio; debt-creating flow; nominal interest rate; debt stock; Credit; Public sector
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The growth outlook remains weak and uncertain. Romania’s decision to rely primarily on expenditure cuts to close the fiscal gap is ambitious, but entails implementation risks. Progress on fiscal reforms has resumed. In the medium term, fiscal policy should aim at a more permanent reduction in the fiscal deficit. The government’s proactive banking supervision, and regulation has helped maintain the stability of the financial system, but vigilance is essential. Pressing ahead with structural reforms is key for boosting growth and achieving sustainable real convergence.

Abstract

The growth outlook remains weak and uncertain. Romania’s decision to rely primarily on expenditure cuts to close the fiscal gap is ambitious, but entails implementation risks. Progress on fiscal reforms has resumed. In the medium term, fiscal policy should aim at a more permanent reduction in the fiscal deficit. The government’s proactive banking supervision, and regulation has helped maintain the stability of the financial system, but vigilance is essential. Pressing ahead with structural reforms is key for boosting growth and achieving sustainable real convergence.

1. This statement provides an update on policy developments and implications for the program since the issuance of the staff report. The additional information changes the staff appraisal.

Fiscal developments

2. On June 25, the Constitutional Court ruled on the package of expenditure cuts agreed with staff and approved by the parliament. The Court accepted the legality of the 25 percent cut in public sector wages and the cuts of 15 percent in most social transfers, but rejected the constitutionality of the 15 percent reduction in pensions. This decision created a gap of 0.7 percent of GDP to achieve the agreed 6.8 percent of GDP deficit target. The authorities responded quickly to implement compensatory measures. On June 26, the Cabinet approved an emergency decree to increase in the standard VAT rate from 19 percent to 24 percent, effective immediately (revised prior action), and on June 29 parliament re-approved legislation to implement the wage cuts accepted by the Court.1 The VAT increase is expected to yield RON 3.6 billion (0.7 percent of GDP) for the remainder of 2010 at current revenue yields, effectively closing the gap created by the rejection of the pension cuts (text table and revised Table 6).

3. The government has taken other actions to fully implement the agreed fiscal consolidation. The cabinet approved the revenue measures that formed part of the agreed adjustment package (0.3 percent of GDP), although these were not part of the prior action. These measures included broadening the tax base for the income tax and social security contributions, and introducing a tax surcharge on owners of multiple properties. Separately, a Ministerial order has been issued to implement the agreed cuts in transfer payments to local governments. This action will be followed up next month by a budget revision law to make the cuts permanent.

Fiscal program

(in percent of GDP)

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Macroeconomic developments

4. Economic indicators available since the issuance of the staff report suggest a weak economic recovery, but downside risks have risen. Industrial production and export growth have remained positive, but demand-related indicators are weak and confidence and economic sentiment indicators are sharply negative. Credit indicators also remain weak, with interest rates affected by increased risk perception for Romania in international markets and credit growth still negative.

5. The VAT increase will have a significant one-off effect on inflation. While passthrough may initially be more subdued due to weak domestic demand, preliminary staff estimates suggest the consumer prices will rise by 3½-4½ percentage points above staff’s previous estimate of 3.7 percent at year-end (revised Table 3). Thus, the NBR will likely miss its 2010 inflation target by a significant margin, but inflation should return to its downward path in 2011.

Pension reform

6. The lengthy debate in parliament on the confidence motion to approve the fiscal package has contributed to a delay in approval of pension reform legislation. While parliamentary committees have approved the draft law, last week the parliament postponed the discussion of the bill to September, which will not allow the structural benchmark to be met by end-June, as agreed (revised Table 2). Staff expects that the legislation will be approved by Parliament by end-September 2010 (reset structural benchmark) and implemented in 2011, as agreed. Therefore, the delay will not have a tangible impact on the program. Moreover, many of the provisions of the legislation that have a short-term impact –such as the elimination of the special noncontributory pensions and tightening disability pension procedures – have been included in recently approved fiscal package, and will actually be in force earlier than anticipated.

Revised proposed decision

7. Staff supports the approval of the requested waivers of applicability of all end-June 2010 performance criteria (other than on the NFA target), as well as of the condition to consult with the Fund based on inflation at end-June. These waivers are needed as data on the end-June 2010 performance criteria and on inflation as of end-June 2010 are not available.

8. A revised proposed decision, granting the requested waivers of applicability, is attached. The net foreign asset targets adjustor for end-June 2010 is no longer proposed to be modified, as data on this target has become available and the target has been met.

Modifications to the staff appraisal

9. Staff continues to support Board approval of the review. The mix between expenditure cuts and revenue measures is now more balanced than in the package originally proposed by the government, and the protection of pensioners will further mitigate negative social effects. Indeed, the proposal is closer to the measures that had been advocated by staff, as discussed in paragraphs 20 and 49, of Country Report No. While implementation risks remain notable (including the possibility that the VAT increases will not be ratified by the parliament), the government’s legal authority to raise taxes makes such risks lower than under the original package. Furthermore, the government’s willingness to implement compensatory measures within hours of the adverse court decision demonstrates considerable political resolve to achieve the objectives of the Fund supported program. Staff and the authorities agreed that parliamentary ratification of the VAT decree will be an end-September 2010 structural benchmark.2

10. Monetary policy will face additional challenges in bringing inflation under control. The sharp short-term inflationary effect of the VAT increase will temporarily push prices outside of the NBR’s desired disinflation path. In staff’s view, there is no immediate need for a change in the monetary policy stance as a result of the direct effects of higher taxation on prices. However, the authorities will have to be vigilant in not accommodating possible second-round inflationary effects. The key will be to gear policy decisions to the projected inflationary path 12–18 months ahead, once the immediate impact of the tax hikes has dissipated.

Table 1.

Romania: Quantitative Program Targets (Revised)

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The December 2008 figure is a stock.

The December 2008 figure is for the whole year.

NFA targets for end December 2009 have been adjusted as actual disbursements fell short of projected levels by EUR 1 bn. Note that the NFA adjustor for June 2010 will remain as described in the Letter of Intent of February 5, 2010, while the adjustors for September and December 2010 are set as described in the Letter of Intent of June 16, 2010.

Table 2.

Romania: Performance for Fourth Review and Proposed New Conditionality (Revised)

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Table 3.

Romania: Selected Economic and Social Indicators, 2007–15 (Revised)

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Sources: Romanian authorities; Fund staff estimates and projections; and World Development Indicators database.

Actual fiscal balance adjusted for the automatic effects of the business cycle.

Table 4.

Romania: Balance of Payments, 2007–15 (Revised)

(In billions of euros, unless otherwise indicated)

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

Includes IMF disbursement to the Treasury of €0.9 billion in 2009 and €1.2 billion in 2010, and issuance of an Euro bond of €1 billion in 2010.

IMF disbursements amounted to €6.8 billion in 2009 and are projected to amount to €5 billion in 2010. Of these €0.9 billion in 2009, and €1.2 billion in 2010 have been disbursed directly to the Treasury, and included in the capital and financial account as noted in footnote 1.

Reflects the allocation of SDR 908.8 million that was made avaialable in two tranches in August and September 2009.

Table 5.

Romania: Gross Financing Requirements, 2009-11 (Revised)

(In billions of euros, unless otherwise indicated)

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Source: IMF staff estimates.

Includes includes portfolio equity, financial derivatives and other investments, assets position.

Excludes the disbursements by the IMF directly to the Treasury, amounting to €0.9 billion in 2009Q3 and €0.8 billion in 2009Q4.

Reflects two SDR allocations in August and September 2009.

Table 6.

Romania: General Government Operations, 2007–15 (Revised)

(In percent of GDP)

(In millions of RON) Sources: Ministry of Finance; Eurostat; and Fund staff projections.

Increase in 2009 mostly reflects higher EU-financed capital spending and budgeted rise in pensions.

Includes co-financing of EU projects.

Does not include all capital spending. Total investment increased from 6.0 percent of GDP in 2008 to 7.0 percent of GDP in the authorities’ 2009 budget.

Total public debt, including government debt, local government debt, and guarantees.

Percentage deviation of actual from potential GDP.
Table 7.

Romania: Monetary Survey, 2007–11 (Revised)

(In millions of lei (RON), unless otherwise indicated; end of period)

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Sources: National Bank of Romania; and Fund staff estimates.

Rates for new local currency denominated transactions.

For interest rates and shares of foreign currency loans and deposits, latest available data.

Table 8.

Romania: Schedule of Reviews and Purchases (Revised)

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Source: IMF staff estimates.

The amount of purchase for the second review was available from December 15, 2009, but was made together with the amount for the third review on February 19, 2010 given the delay in completing the second review.

Table 9.

Romania: Indicators of Fund Credit, 2010–16 1/ (Revised)

(In millions of SDR)

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Source: IMF staff estimates.

Using IMF actual disbursements, SDR interest rate as well as exchange rate of SDR/US$ and US$/€ of June 3, 2010.

End of period.

Repayment schedule based on repurchase obligations.

Table 10.

Romania: Public Sector Debt Sustainability Framework, 2005–15 (Revised)

(In percent of GDP, unless otherwise indicated)

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Coverage: general government. Gross public debt excluding guarantees is used.

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

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π(1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

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

Table 11.

Romania: External Debt Sustainability Framework, 2005-2015 (Revised)

(In percent of GDP, unless otherwise indicated)

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

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

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

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

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

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

Annex I: Romania: Supplementary Letter of Intent

Mr. Dominique Strauss-Kahn

Managing Director

International Monetary Fund

Washington, DC, 20431

U.S.A.

Bucharest, June 29, 2010

Dear Mr. Strauss-Kahn:

1. This letter updates our Letter of Intent (LOI) of June 16, 2010. On June 25, the Constitutional Court invalidated the 15 percent cut in pensions approved by parliament, which formed part of the prior action (the cuts in wage and social transfers were not affected). To close the financing gap opened by the Constitutional Court decision, we have approved by emergency ordinance an increase in the VAT rate from 19 to 24 percent, effective immediately. The publication of this ordinance in the official gazette, which enacts the VAT increase, is a prior action for Board consideration of the fourth review. Moreover, parliamentary ratification of the VAT increase and of the expenditure measures that had been found constitutional will be a structural benchmark for end-September for 2010 (Table 2).

2. The change in the composition of this year’s fiscal adjustment affects several targets under the program. In particular: (i) the increase in the VAT will have a temporary but significant impact on inflation, which we estimate at 3½-4½ percent and which will push inflation outside of the NBR’s targeted path; (ii) the indicative target on general government current primary spending will be affected by the invalidation of the pension cuts; and (iii) the projected revenues used for the deficit target adjustor will be affected by the VAT increase. We therefore propose that these targets and projections be modified as indicated in the attached Table 1.

Table 1.

Romania: Quantitative Program Targets (Revised)

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The December 2008 figure is a stock.

The December 2008 figure is for the whole year.

NFA targets for end December 2009 have been adjusted as actual disbursements fell short of projected levels by EUR 1 bn. Note that the NFA adjustor for June 2010 will remain as described in the Letter of Intent of February 5, 2010, while the adjustors for September and December 2010 are set as described in the Letter of Intent of June 16, 2010.

3. The lengthy parliamentary debate on the fiscal adjustment package has contributed to some delays in the approval of the pension reform legislation. The discussion of the bill was postponed to September, which has not allowed the structural benchmark to be met by end-June. We expect the legislation to be approved by parliament by end-September 2010 (reset of structural benchmark, see Table 2), with the reform implemented from 2011, as agreed under the program. Moreover, some provisions of the legislation that have a short-term impact, such as the elimination of the special noncontributory pensions and tightening of the disability pension procedures, have been included in the fiscal package legislation and will be in force earlier than anticipated.

Table 2.

Romania: Performance for Fourth Review and Proposed New Conditionality (Revised)

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4. We request that a waiver of applicability be approved for all end-June 2010 performance criteria other than for the net foreign assets target, as information on these criteria is not available. The net foreign assets target for end-June 2010, which has been observed, remains as established at the completion of the second and third reviews. We also request a waiver with respect to the inflation consultation band for end-June 2010 since information on inflation as of end-June is also not yet available. Finally, we note that our LOI of June 16, 2010 referred to a fiscal target of 6.8 percent for 2009 (paragraph 7) and we wanted to clarify that this target is for 2010.

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1

Under Romanian law, when the Constitutional Court rules part of a law unconstitutional, it returns the whole law to parliament for action. Thus, the wage cuts (which were accepted) do not go into effect automatically. For this reason, the parliament had to re-approve them as new legislation. Staff reached an understanding with the authorities to require parliamentary approval of the wage cuts and of the decree increasing the VAT as an end-September 2010 structural benchmark. Parliamentary approval of the wage cuts on June 29 partially met the benchmark.

2

In the unlikely event that the parliament rejected the measure, staff would negotiate a new mix of expenditure and revenue measures to achieve the targeted adjustment.

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Cover IMF Staff Country Reports
Romania: Staff Report for the 2010 Article IV Consultation, Fourth Review Under the Stand-By Arrangement, and Requests for Modification and Waiver of Nonobservance of Performance Criteria—Staff Report; Staff Supplement; Public Information Notice and Press Release on the Executive Board Discussion; Statement by the Executive Director for Romania.
Author:
International Monetary Fund
Volume/Issue:
Volume 2010: Issue 227
Publisher:
International Monetary Fund
ISBN:
9781455203468
ISSN:
1934-7685
Pages:
153
DOI:
https://doi.org/10.5089/9781455203468.002