Romania-Seventh Review Under the Stand-By Arrangement, Cancellation of Current Stand-By Arrangement, and Request for a New Stand-By Arrangement-Staff Report; Supplement on the Assessment of the Risks to the Fund and the Fund's Liquidity Position; Supplementary Information; Press Release on the Executive Board Discussion; Statement by the Executive Director and the Senior Advisor to the Executive Director for Romania
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International Monetary Fund
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Publication Date:
01 Apr 2011
eISBN:
9781455230075
Language:
English
Keywords:
ISCR; CR; Stand-By Arrangement; government; Romania; February inflation; debt ratio; current account; trade balance; nominal interest rate; long-term debt; Inflation; Current account deficits; Western Europe
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Romania’s external position continues to improve. Inflation peaked in December 2010, and is now likely to decline. Financial market stress has remained relatively low in recent months. The current account deficit improved from 13½ percent of GDP in 2007 to about 4¼ percent of GDP in 2010, driven by a strong shrinking trade deficit. Significant progress has been made under the Stand-By Arrangement (SBA) in achieving fiscal consolidation and safeguarding the financial sector. Most performance criteria and structural benchmarks were met throughout the program.

Abstract

Romania’s external position continues to improve. Inflation peaked in December 2010, and is now likely to decline. Financial market stress has remained relatively low in recent months. The current account deficit improved from 13½ percent of GDP in 2007 to about 4¼ percent of GDP in 2010, driven by a strong shrinking trade deficit. Significant progress has been made under the Stand-By Arrangement (SBA) in achieving fiscal consolidation and safeguarding the financial sector. Most performance criteria and structural benchmarks were met throughout the program.

I. Introduction and Summary

1. The economy has stabilized and growth is now resuming. Data for Q4 2010 and recent indicators suggest that growth has restarted and will slowly gain momentum in 2011 to around 1½ percent. Growth is expected to accelerate in 2012, reaching 4–4½ percent. Inflation, driven by high food and fuel prices and the recent VAT hike, likely peaked at end-2010, and is expected to return to the central bank’s target range (3 percent ± 1 ppt).

2. The program will end broadly on track. Performance criteria for the seventh review have been met except for the criterion on government arrears, (for which a waiver was already granted). While progress has been made in eliminating central government arrears, substantial arrears continue in local governments. The indicative targets on loss-making state-owned enterprises (SOEs) and current spending were missed. The structural benchmark regarding tax administration for high net wealth individuals was met, and that on parliamentary ratification of amendments to the bank resolution framework was partially met, as some amendments were ratified, but ratification is still pending in parliament for others. The structural benchmark for mid-March regarding integrating accounting reporting with the Treasury payment system was met, but there will be a delay in amending legislation to permit the use of the deposit guarantee fund to facilitate bank restructuring.

3. The successor SBA will focus on boosting potential growth through structural reforms. Structural deficiencies in key economic areas weigh heavily on economic growth. Improved efficiency of the public sector will reduce bureaucratic barriers to economic efficiency and will increase the absorption of EU structural funds to boost capital spending to improve the country’s infrastructure. The new program also aims at deep-rooted reforms in the energy and transport sectors, including pricing reforms, improved regulation, and the restructuring and privatization of energy and transport SOEs. Fund and EU precautionary support will reassure private markets and provide a cushion against future shocks, should they materialize.

4. Fiscal adjustment will continue. The end-December fiscal balance target was met with a substantial margin, reflecting higher-than-expected tax revenues. The difficult fiscal measures enacted in 2010, complemented with continued prudent expenditure policies, put the fiscal cash deficit targets of 4.4 percent in 2011 and 3.0 percent in 2012 well within reach. However, continued efforts to improve tax collections, tackle expenditure pressures (particularly in the health sector), and reduce arrears will be crucial to sustained deficit reduction. As part of ongoing tax administration improvements, the government will pass an ordinance on indirect audit methods (¶17) as a prior action for the new SBA.

5. The banking sector has weathered the crisis well, remaining well-capitalized and liquid. Non-performing loans continue to increase, but at a declining pace and are expected to peak in mid-2011. Banks remain well-capitalized, with an average capital adequacy ratio of 14.7 percent and all banks above 11 percent at end-2010. However, the continued

6. vigilance is required, as performance will vary significantly across banks. In March, the authorities will discuss an extension of the European Bank Coordination Initiative (EBCI) with the largest foreign-owned banks, with a view toward continuing its stabilizing effects.

II. Recent Developments

7. The Romanian economy is beginning to recover. Recent data show slight positive growth in Q4 2010, while revisions to previous quarters have produced a better outturn for the year than previously expected (-1.3 percent). Strong export growth continues and industrial production remains robust; however, weak retail sales persist. Registered unemployment has decreased, but mainly due to shrinking labor force participation rather than job creation.

8. Inflation peaked in December 2010, and is now likely to decline. Headline CPI inflation reached 8.0 percent in December before dropping to 7.0 percent in January. The initial pass-through of the 5 percentage points VAT hike in July 2010 was roughly as expected, but inflation was boosted by increased fuel and food prices (reflecting higher world prices).

uA01fig01

Industrial Production

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

uA01fig02

Private consumption and retail trade

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

Source: Haver, Staff Estimates.

9. Financial market stress has remained relatively low in recent months. The CDS spread for sovereign debt has narrowed by around 100 basis points since September, now below several other EU countries. Romanian equity markets have recovered since their June trough. Thus far, the turbulence in the Euro area periphery has had little direct impact on Romania, though risks remain. Since summer 2010, the leu has remained relatively stable, obviating the need for significant central bank intervention.

uA01fig03

National Currency per Euro

(July 1, 2008 = 100)

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

uA01fig04

CDS, 5-years

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

Source: Haver, Bloomberg: Staff Estimates.

10. Romania’s external position continues to improve. The current account deficit improved from 13½ percent of GDP in 2007 to around 4¼ percent of GDP in 2010, driven by a strong shrinking trade deficit. Exports are booming, driven by the manufacturing sector. On the transfers side, workers’ remittances have shrunk due to the recession and high unemployment in host economies. Foreign direct investment (FDI) continued to be weak, financing less than half of the current account deficit, while official financing remained the major source of inflows. The depreciation of the leu experienced since mid-2007 has produced an improvement of roughly 15 percent in competitiveness, as measured by the Real Effective Exchange Rate.

uA01fig05

Exports (SA), Imports (SA), Trade balance 12m

(billion Euros)

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

Source: Haver, Staff Estimates.

III. Performance under the Current Program

11. Significant progress has been made under the SBA in achieving fiscal consolidation and safeguarding the financial sector. While the 2009–10 recession turned out to be deeper and more prolonged than originally anticipated, important adjustment efforts under the SBA have positioned Romania to generate sustainable growth in the coming years (Box 1). A structural fiscal deficit of almost 9 percent of GDP in 2008 was halved by 2010, and the government finances are broadly on track toward respecting the 3 percent of GDP Maastricht deficit limit in 2012. Financial sector measures helped maintain adequate capitalization of banks and liquidity in domestic markets, ensuring banking sector stability. Excessive capital outflows were avoided (in part reflecting the EBCI), and an orderly adjustment of the current account was made possible without undue exchange rate volatility. Structural reforms in tax administration, pensions, public wages and employment, and social benefits will ease fiscal pressures in the medium-term, while improving public sector efficiency and setting the stage for more widespread improvements in the business climate.

12. Most performance criteria and structural benchmarks were met throughout the program, including for the seventh and final review. The performance criteria on government guarantees, external arrears, and net foreign assets were consistently met throughout the program, including for the seventh review. The fiscal deficit target was observed for all but the fourth program review, including by a significant margin for end-December 2010. In contrast, the general government arrears criterion was missed in all reviews.1 While the central government and social security sector payment arrears have fallen significantly during the program (now under 0.05 percent of GDP), arrears from local governments continue to pose a challenge. Inflation has remained within the inner band of the inflation consultation mechanism throughout the program, though the band was adjusted after the VAT increase in mid-2010. Structural benchmarks, focused primarily on fiscal and financial sector reforms, have generally been met. For the seventh review, the indicative target on current spending was missed, as the authorities used some of the overperformance on revenues to allow for higher discretionary outlays. The indicative target on the operating balances of selected SOEs was also missed, which is symptomatic of the need for more profound SOE reforms under the new program.

Major Measures Under the SBA, 2009–11

The adjustment in the structural fiscal deficit between 2008 and 2011 totaled some 7 percentage points of GDP, with additional savings expected in future years from public wage and pension reforms.

On the expenditure side, main measures included:

  • Streamlined public employment (by over 100,000).

  • A public sector wage cut of 25 percent (partly offset by 15 percent increase in 2011).

  • Elimination of holiday bonuses and the 13th salary.

  • Inefficient social benefits cut (15 percent) and reinforced social inspections.

  • Central government arrears reduced to near zero.

On the revenue side, measures included:

  • Broadening the tax base and improved tax collection.

  • Hikes in VAT rates (from 19 to 24 percent) and excise tax rates.

  • A rise in social security contribution rates (3 ppts.).

Structural reforms included:

  • A major pension reform was approved to increase retirement ages, move indexation from wages to inflation, and reduce incentives for early retirement, while continuing to build the second pension pillar.

  • The public wage system was reformed, harmonizing wages across ministries and significantly reducing the role of bonuses in compensation.

  • Social benefits were reformed—including unemployment insurance, social assistance programs, and maternity benefits—to improve efficiency while reducing costs.

  • Major health sector reforms were begun to improve efficiency, cost recovery, and financial performance.

  • Legislation was approved mitigating fiscal risks from local governments.

  • A Fiscal Responsibility Law was introduced to improve medium term budget framework and budget execution.

  • A Fiscal Council was established as an independent body to monitor fiscal policy.

In the financial sector:

  • Support from parent banking groups was secured through the EBCI.

  • Continued proactive and intensive supervision by the NBR helped to avoid significant bank difficulties.

  • The bank resolution framework was significantly enhanced.

  • The funding of the deposit guarantee scheme was strengthened.

IV. Elements of the New Program

A. Overall Program Objectives

13. The proposed follow-up program aims to provide precautionary support against possible future economic shocks, while assisting Romania in continuing its economic adjustment. Building on the achievements of the current SBA, the key objectives of the new program are to: (i) continue the fiscal adjustment process while attacking problems of revenue and expenditure efficiency, and arrears; (ii) boost growth potential through structural reforms and improved flexibility of the economy, which will allow for continued competitiveness as Romania prepares for eventual euro area entry; and (iii) continue fostering confidence, facilitating improved private capital flows, by improving policy stability and the business climate.

14. Fiscal policy will be anchored on the authorities’ commitment to reducing the deficit to within 3 percent of GDP by 2012. Adjustment measures already taken should deliver the targeted 4.4 percent of GDP cash deficit by 2011, but further action may be needed in 2012. Fiscal reforms will concentrate on remaining problem areas, including health care and capital expenditure reforms, further efforts to tackle arrears, and improvements in tax administration and simplification. These reforms should also boost growth by reducing bureaucracy and boosting absorption of EU funds.

15. Structural reforms aim to eliminate barriers to growth while boosting investment and job creation. The new program will include a comprehensive SOE reform strategy focusing particularly on the energy and transport sectors, improving regulators’ effectiveness, and opening markets (reforming administered prices), while protecting vulnerable members of society. The authorities will also pursue their efforts at labor market reforms and social benefits reforms, crucial to job creation and maintaining Romania’s competitiveness.

B. Macroeconomic Framework and Risks

16. The new program is based on a forecast of a gradual return to growth in 2011–12, abating inflationary pressures, and a stable current account.

  • Growth. GDP growth is expected to pick up during 2011, reaching around 1½ percent as both incomes and employment gradually recover. Growth will accelerate to 4–4½ percent in 2012 and remain there in the medium-term, with domestic demand increasingly becoming the main driver, supported by improved EU funds absorption. The contribution from external demand will slow in line with moderate growth of export markets. Increased investor confidence, coupled with planned privatization under the program will bring renewed FDI and banking inflows.

  • Inflation. Staff expects that CPI inflation will gradually return to the NBR’s target band in the second half of 2011 as pressures from the recent VAT hike and rising food and fuel prices gradually subside. For 2012, further disinflation toward 3 percent is expected.

  • External position. The current account deficit is projected to stabilize at around 4–5 percent of GDP in 2011–12. Export growth will moderate in 2011, leading to a slight worsening of the trade balance. Private capital inflows are expected to improve over the program period, with FDI rebounding from recession lows and portfolio inflows also recovering. Under staff’s baseline scenario, no new financing gap is envisaged, consistent with the new program’s precautionary nature.

  • Risks. Growth and balance of payments risks are largely balanced, but inflation risks are tilted to the upside. On the downside, domestic political tensions could lead to policy reversals, dampening confidence, and weakening performance; a weaker-than- expected recovery in Western Europe or spillovers from the ongoing turbulence in the euro area periphery could dampen exports or raise risk premia and affect capital flows to Romania. On the upside, a faster-than-expected recovery of consumer confidence and domestic demand or improved EU funds absorption and rapid implementation of structural reforms could catalyze faster growth and prompt a higher current account deficit funded by greater capital inflows. Prospects of reaching the inflation target could be adversely affected by a continued resurgence in world food and energy prices, while needed increases in administered prices may also boost inflation.

Romania: Macroeconomic Outlook

article image
uA01fig06

INFLATION TARGETS AND OUTCOMES

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

Source: Haver; Staff estimates.

C. Fiscal Policies

17. Current fiscal policy is broadly appropriate for bringing the fiscal deficit to a sustainable level during the new program period. The full-year effect of the July 2010 fiscal adjustment package along with continued expenditure restraint should help reach the agreed 2011 cash deficit target of 4.4 percent of GDP (from 7.3 percent of GDP in 2009). Key measures include an extension of the pension freeze, continued public employment reductions, elimination of stimulente funds (structural benchmark, end-June), expanding the base of healthcare contributions to more pensioners, and replacing heating subsidies with targeted assistance, and further savings expected from health sector (LOI ¶14–15) and education reforms. In the course of 2011, some loss-making SOEs will be brought under the definition of the general government annually adding around ½ percent of GDP to the deficit.2 For 2012, renewed economic growth combined with prudent expenditure policies would bring the cash deficit to near 3 percent of GDP, though some additional measures may be needed. The cash deficit target may have to be modified in 2011 to partly accommodate the change in definition of the general government, however, in 2012 additional measures may be required to bring the accrual-based deficit within the Maastricht limit.

18. Despite the progress achieved, there are still significant fiscal problems to be addressed in the follow-up arrangement. On the revenue side, Romania’s crisis stabilization has relied to a significant degree on raising tax rates to relatively high levels, while the efficiency of tax collection remains very low. The general VAT rate now stands at 24 percent and social contributions are over 40 percent of wages. The simplicity and ease of payment of the tax system are also substandard.3 Under the new program, the authorities will continue tax administration reforms (advised by FAD) and will undertake a comprehensive review of the tax system with a view towards a revenue-neutral tax simplification. Following removal of multiple tax forms, options to reduce frequency of filing and create a unified tax declaration are being examined, as well as expansion of e-filing. A government decision on indirect audit methods will be passed (prior action) and a strategy and action plan developed for incorporating these methods into compliance functions.4 Allocation of resources towards medium and large taxpayers will be improved by requesting the EU Council of Ministers for an increased VAT mandatory threshold of €50,000 while instituting simplified taxation for taxpayers under the threshold (structural benchmark, end-June 2011).

19. On the expenditure side, improving expenditure efficiency and implementing a comprehensive solution to payments arrears are priorities. By end-2010, central government and social security sector arrears had declined to near zero. On the local level, arrears have fallen below 0.2 percent of GDP and should continue declining with new legislation (effective January 2011) tightening local government financial management. To assess their full extent, a stocktaking of arrears and unpaid bills as of end-2010 will be conducted for the entire general government as well as SOEs and an action plan prepared by end-April 2011 (structural benchmark), after which payments will not be authorized for unregistered bills.5 Central government and social security arrears will be fully eliminated during the program. To avoid future general government arrears, the authorities will also implement further health sector reforms (¶19) to reduce overdue payments and bring spending into line with budgetary allocations and complete on-going integration of accounting and Treasury payment systems (LOI ¶10) to better control expenditure commitments. During the new program, the deadline for payments will be reduced from the current 90 days to, in most cases, 30 days in line with new EU requirements. More broadly, the new program will make use of the recent functional expenditure reviews conducted by the World Bank (with EU support) to develop measures to improve expenditure efficiency. Beyond the general government, SOE reforms (¶24-25) will include comprehensive plans to reduce their arrears (via payments, liquidations, use of privatization proceeds, and/or debt restructuring).

uA01fig07

General Government Arrears and Unpaid Bills

(bn RON)

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

Source: Romania Authorities; Staff Estimates.

20. Health care reforms will be critical to safeguarding fiscal consolidation. Significant spending pressures have been generated in recent years by a fundamental mismatch between the entitlements for medical care and the resources available from the budget, contributing to arrears accumulation. Measures under the new program include: reforming the government-insured benefits package to exclude coverage of costly nonessential services; introducing a “money follows the patient” mechanism; using generic rather than brand drugs wherever possible; and reducing excess public sector hospital beds with a view to reaching the EU average by 2013. The authorities are also advancing on the introduction of national health cards, electronic patient records, and electronic prescriptions.

21. Despite significant public employment reforms under the current program, additional measures are needed. Public employment shrank from 1.4 to 1.3 million people during 2010, with the largest declines in local governments and the education sector, as standard norms for local government personnel were implemented and student- teacher ratios moved closer to the EU average. However, further employment rationalization in the context of recent World Bank functional reviews is needed, especially given that the new unified wage scheme will only be fully effective over time.

uA01fig08

Public Sector Employment

(in Millions, end of period)

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

Source: Minister of Public Finance; Staff Estimates.

22. Public investment policies require significant reforms to increase efficiency and enhance the absorption of EU structural funds. Romania spends a large share of its GDP on public investment (averaging over 6 percent of GDP in recent years), but capital spending has been plagued by inefficiency and under 3 percent of the €19 billion in available EU structural funds have been utilized. To better coordinate EU funds absorption, the EU funds unit will be moved from the Ministry of Public Finance (MOPF) to the Prime Minister’s office. Measures to improve capital budgeting and project implementation (LOI ¶13) include comprehensive review, evaluation, and prioritization of projects within the existing investment portfolio; focusing on those where funding can be fully secured within a medium- term horizon (e.g., 3–5 years); and discontinuing low priority and non-performing projects. A final report and action plan will be produced by end-September 2011 (structural benchmark).

23. The fiscal financing strategy will focus on moving away from multilateral budgetary support to full reliance on financial markets. The recently prepared debt management strategy aims at extending the maturity of domestic debt, building the yield curve, and consolidating financial buffers. The authorities have made progress in recent months in building the domestic yield curve, and their euro medium-term notes program for regular debt financing in the Eurobond market is underway. Financing buffers will be brought to around four months of financing needs in 2011 and maintained at that level. A formal review of the government’s debt management strategy, with the assistance of IMF staff, the EC, and the World Bank, will also be conducted in 2011.

D. Structural Reforms

State-Owned Enterprises

24. SOEs constitute a significant fiscal burden and constrain private sector growth (Box 2). Romania’s post-communist privatization process has stalled in recent years, leaving inefficient state firms dominant in key economic sectors, such as energy and transportation. SOEs receive budgetary subsidies equivalent to around ½ percent of GDP annually and many generate considerable operating losses.6 SOEs have accumulated arrears of around 4 percent of GDP to private sector firms and other public sector entities, damaging their financial health, reducing investment, and job creation. Moreover, inefficient operations and poor quality service of SOEs increase operating costs of private firms and create a barrier to augmenting exports and investments.

25. To generate higher sustainable growth, the new program aims at deep-rooted SOE reform (LOI ¶23). Action plans for key firms will classify them as in line for liquidation, privatization, or restructuring, and will contain concrete arrears-reducing strategies (structural benchmark, end-April 2011). Major financial and operational indicators of all SOEs (at central and local government levels) will be regularly reported to the MOPF. Governance issues will be addressed via regular independent external audits and by moving financial control of SOEs from line ministries to the MOPF.

26. Reforms will focus on the energy and transport sectors, where regulatory and pricing issues, combined with the dominance of SOEs, drag down economic growth. The energy and transport sectors include most of the largest SOEs (including the largest loss-makers and those with the largest arrears). Moreover, these sectors constitute key bottlenecks for accelerating GDP growth and for EU funds absorption.

  • In the energy sector, the authorities will restore the energy regulator’s full operational and financial autonomy, and will phase out regulated prices in electricity and gas, while protecting vulnerable groups. Minority and/or strategic private investors will be brought into key energy firms, including Transelectrica, Transgaz, Romgaz, and Petrom,7 as well as firms slated to be included in the two “national champion” companies (whose creation, in staff’s view would compromise the viability of “good” energy assets by combining them with undesirable ones).8 Unprofitable coal companies will also continue to be downsized, with viable assets spun off. A similar strategy of separating viable assets will be followed for Termoelectrica.

  • In the transport sector, passenger railway and infrastructure service will be restructured with reductions in coverage (closure of 1000 kms. of unfrequented railway lines by end-August), competitive tendering for public service and infrastructure maintenance, and a significant decrease in losses and arrears. Passenger railway and the Bucharest metro system are scheduled to improve cost recovery through higher tariffs. Strategic investors will be sought for the rail freight company (CFR Marfa) and the national air carrier (Tarom) (LOI ¶29).

State-Owned Enterprises in Romania: Taking Stock

The list of SOEs in Romania currently includes majority stakes in 154 companies, numerous minority stakes as well as around 25 autonomous institutions at the central government level alone. In addition, the portfolio of the privatization agency, AVAS, comprises 19 majority and about 350 minority stakes.

Detailed information is only available for the 154 companies. They employ more than 250,000 people, representing about 6 percent of all employees. The financial situation of these companies continues to deteriorate. Expenditures have fallen little despite cost-cutting measures, including a reduction of 28,000 employees since end-2008. In 2010, revenues increased, mainly based on increasing tariffs, including the installation of an electronic road toll system as well as higher tariffs for passenger rail. In the first three quarters of 2010, subsidies paid to these companies increased to around ½ percent of GDP. In addition, the stock of arrears has reached more than 4 percent of GDP.

Out of the 154 companies, 83 are held by the Ministry of Economy (especially in the energy sector) and 36 by the Ministry of Transport and Infrastructure. Operating losses are concentrated in the Ministry of Transport, Ministry of Agriculture, and Ministry of Communication. Subsidies are largely paid to companies under the control of the Ministry of Transport, Ministry of Economy, and Ministry of Agriculture. Basically, the entire stock of arrears has been accumulated by companies under the control of the Ministry of Economy (57 percent) and Ministry of Transport (42 percent).

uA01fig09

154 SOEs: Arrears and personnel, 2008–10

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

uA01fig10

154 SOEs: Revenues, expenditures, subsidies & profit, 2008–10, bn. lei

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

Other reforms

27. Social benefits and labor market reform will also play an important role in fiscal consolidation and improving growth. Social benefits reforms (Box 1) have already yielded significant fiscal savings and are expected to improve incentives for work while providing support for the neediest. The authorities are nearing completing of a package of labor reforms to improve labor flexibility, increase labor force participation, and enhancing the representativity of collective bargaining while making the wage-setting process more flexible and allow for a better orientation of wage growth on productivity developments.

E. Financial Sector Policies

28. Growth in non-performing loans slowed significantly in recent months and the banking sector remains liquid and well capitalized. Non-performing loans, expected to peak in mid-2011, grew at a slower pace in the last quarter—rising to 11.9 percent9 at end-December. Profitability turned negative by mid-2010, but the banking system retains adequate buffers with an average capital adequacy ratio of 14.7 percent at the end of 2010, while all banks remained above 11 percent (compared to the statutory minimum of 8 percent). As the economic recovery gains traction and loan loss provisions stabilize over the first half of 2011, the banking sector as a whole is expected to return to profitability. The parents of the largest foreign subsidiaries maintained aggregate exposures under the EBCI of 98 percent at end-January 2011, well above the July 2010 commitment of 95 percent.

Romanian Banking System - Core Indicators

(in percent)

article image
Source: NBR.

Tier 1 capital/ total average net assets

Unadjusted exposure from loans and interest falling under “doubtful” and “loss” / total classified loans and interest, excluding off-balance sheet items.

Unadjusted exposure from loans classified as “loss” defined as past 90 days and/or initiation of legal preceeding/ total loans and interest, excluding off-balance sheet items.

Cash, sight and term deposits with banks plus government securities free of pledge/ total liabilities

29. Under the existing program, the authorities have undertaken significant reforms to strengthen the financial safety net. However, there have been some delays in a reform to enable the Deposit Guarantee Fund (DGF) to finance the new bank resolution and restructuring tools, which will be completed under the new program (now expected by end-June 2011). The NBR (in conjunction with the DGF) will also develop operating procedures and contingency plans for deploying the new resolution tools. The authorities will ensure that the DGF has ready access to liquidity to meet any potential shortfalls in funding and prepare joint procedures for deploying DGF funds in a bank resolution. The authorities will also review the DGF banking and the winding-up legislation to ensure their mutual consistency.

30. Significant reform is also underway on the regulatory front. Preparations have already begun to introduce International Financial Reporting Standards (IFRS) for the banking sector in 2012. By end-June 2011, the NBR will prepare proposals for prudential filters to allow for continued higher provisions to reflect the difficulties banks face in enforcing collateral in Romania. The NBR will continue to closely monitor credit conditions and assess the future evolution of NPLs and banks’ profitability, to identify any potential further capital needs at individual institutions. It will also take action as needed to address the risks of lending in foreign exchange to un-hedged borrowers. The authorities are committed to refrain from promoting legislative initiatives (such as the current draft of the personal insolvency law or proposals for the debt collecting law) which could undermine debt or discipline. The authorities will also ensure that the prudential treatment of debt for equity swaps does not result in a weakening of banks’ financial positions, such that the value of equity is fully deducted from their own funds of credit institutions and the revenues obtained by releasing loan-loss provisions due to these operations are not taxed.

31. The NBR will need to remain vigilant. Some small- and medium-sized banks with high cost ratios, rising loan impairments and lower than average provisions, will continue to incur losses. Further capital injections may be required from existing shareholders or new investors in some cases, while losses could be absorbed from existing buffers in other cases. In March, the NBR will discuss an extension of the EBCI agreement with the largest foreign banks with a view toward continuing the stabilizing effects of the agreement.

F. Monetary and Exchange Rate Policies

32. The central bank has paused its monetary policy easing, pending a clear signal that inflationary pressures are easing. After a 4 percentage point cumulative reduction in interest rates since early 2009, the NBR has left its key policy rate unchanged since July 2010 due to uncertainties associated with the VAT increase as well as food and fuel prices. The authorities believe that heightened vigilance will be needed to keep inflation expectations contained and stave off possible second-round inflationary effects. Reserve requirements have also remained unchanged since November 2009.10

33. Despite the NBR’s decision to pause further policy loosening, monetary conditions have moderated further, reflecting continued reductions in deposit and lending rates in the banking system. Lending rates, however, did not fall by as much, as banks raised lending margins to cover increased provisioning due to continued increases in non-performing loans (NPLs). This policy easing was facilitated by the heavy reliance of the NBR on the overnight standing facility for absorbing liquidity at a rate well below the policy rate, though in recent weeks this excess liquidity seems to be disappearing.11 The exchange rate has remained in a relatively narrow band (RON 4.1–4.3/€) in recent months, despite only modest NBR intervention in support of the currency. The real exchange rate assessment has not changed since the latest Article IV consultation (i.e., slight overvaluation).

uA01fig11

MONETARY CONDITIONS INDEX 1/

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

1/ Weighted average of the annual change in the 3-month interbank offer rate and the nominal effective exchange rate (at a ratio of 1.5 to 1)Source: Bloomberg; IFS; Staff Estimates.
uA01fig12

INTEREST RATES

ON RON INSTRUMENTS

(in percent)

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

Source: National Bank of Romania; Haver.

34. The program’s NFA target contemplates a gradual increase over 2011 parallel to augmenting gross reserves, mainly due to official inflows, and a relatively modest improvement in 2012. This reserve accumulation should place the NBR in a position to effectively service the peak repayments to the Fund in 2013 while maintaining reserve coverage of at least 100 percent of annual short-term financial liabilities. A consultation clause is included in the program requiring that the authorities confer with staff if reserve losses exceed €2 billion in any 30 day period.12

Net Official Inflows

(millions of Euro)

article image

V. Program Modalities

A. Access

35. Romania is not expected to face actual balance of payments financing needs in 2011 and 2012, though financing risks remain. As described in ¶15, under staff’s assumptions, private and non-program public flows should fully cover the current account deficit once multilateral disbursements under the existing program are completed. FDI should cover close to half of the current account deficit, with renewed private portfolio and banking inflows covering the rest.

36. However, if downside financing and growth risks materialize, the authorities might need to draw under the new arrangement. Under staff’s stress scenario (Tables 7–8), higher perceived risks would reduce FDI and rollover rates on private sector external liabilities would drop below 100 percent as banks repatriate some resources (commitments under the EBCI will gradually decline) and corporations find less access to external financing.13 A weaker euro area recovery would also dampen exports. Economic growth would fall by a cumulative 3 percentage points in 2011–12 compared to the baseline. Lower capital inflows would require additional external financing of €5 billion, which would be covered by disbursements from the Fund and the EU.

Table 1.

Romania: Quantitative Program Targets for Seventh Review

article image

The December 2008 figure is a stock.

Performance criterion for January 2011 and indicative target for March 2011 are relative to December 2010 target.

Cumulative figure during calendar year (e.g. March 2011 figure is cumulative from January 1, 2011).

In accordance with TMU, the end-September and end-December program targets were adjusted from the original target of -28,200 and -34,650 by one-half of the revenue over-performance.

The target for March 2011 can be adjusted with higher or lower capital spending as defined in TMU.

Table 2.

Romania: Performance for Seventh Review

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Table 3.

Romania: Quantitative Program Targets for New Program

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The end-December 2010 figure is a stock.

Cumulative flows relative to end-December 2010 stock.

Cumulative figure during calendar year (e.g. March 2011 figure is cumulative from January 1, 2011).

The target for March 2011 can be adjusted with higher or lower capital spending as defined in TMU.

Table 4.

Romania: Conditionality for New Program

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Table 5.

Romania: Selected Economic and Social Indicators, 2007–12

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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 6:

Romania: Macroeconomic Framework, Current Policies, 2008–2016

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

Actual fiscal balance adjusted for the automatic effects of internal imbalance (output gap) and external imbalance (absorption gap) on the fiscal position.

Table 7.

Romania: Balance of Payments, 2008–16

(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 €1 billion Eurobond included in the capital and financial account as noted in footnote 1.

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

Table 8.

Romania: Gross Financing Requirements, 2010-12

(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.

Last disbursement of the current program is treated as precautionary

37. The successor arrangement would begin on March 31, 2011, following completion of the seventh review and cancellation of the current SBA. In order to provide a sufficient financing cushion against unforeseen shocks over the program period, the program is based on total support of €5.4 billion with precautionary support from the Fund (€3.6 billion), precautionary support from the European Union (€1.4 billion), and €0.4 billion from the World Bank. In addition, about €1.2 billion in incremental lending from the EBRD, EIB, and IFC is projected during the program period. Given Romania’s cumulative use of Fund resources, the new program of SDR 3,090.6 million (300 percent of quota) entails exceptional access. Staff assesses that Romania meets the four criteria for exceptional access (Box 3) and considers that SBA terms are appropriate. Program resources would be made available at 131 percent of quota in 2011, 167 percent of quota in 2012 and 2 percent of quota in 2013. For the first year, disbursements would be 6 percent of quota at the approval of the program, followed by 3 equal installments (of 41.7 percent of quota) in the first three quarterly reviews.

Precautionary Financing

(billion Euros)1

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Under follow up arrangement.

Exact EC financing amounts will be decided once a request for disbursement has been made.

B. Capacity to Repay the Fund and Risks to the Program

38. Romania’s capacity to repay the Fund would remain strong. Fund credit outstanding would peak in 2011 at 36.9 percent of gross reserves. Peak payments would be in 2013–14 at a still manageable 11.9 and 12.2 percent of gross reserves and around 9.0 and 8.4 percent of exports of goods and services (Table 13). While this exposure remains large, servicing risks are mitigated by the relatively low level of public debt. Direct public indebtedness is expected to remain under 37 percent of GDP, with public external debt peaking at around 16 percent of GDP in 2011 (Table 9). Total external debt is projected to increase to about 83 percent of GDP at end-2012, but the declining current account deficit and a return to economic growth would gradually reduce it to manageable levels in the medium term (Table 15). Romania’s strong political commitment to the SBA program and its excellent track record servicing external obligations also provide comfort that it will fulfill its financial obligations to the Fund in a timely manner.

Table 9.

Romania: General Government Operations, 2008–12

(In percent of GDP)

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Sources: Ministry of Finance; Eurostat; and Fund staff projections.

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

Projected increase in pensions in 2011 is due to a reclassification of some pensions from the state budget to the pension fund.

Includes co-financing of EU projects.

In 2011, projected increase is due to higher outlays in state aid and transfers to state agencies for investments.

Does not include all capital spending.

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

Percentage deviation of actual from potential GDP.

Table 9.

Romania: General Government Operations, 2008–12 (concluded)

(In millions of RON)

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

Table 10.

Romania: Monetary Survey, 2009–12

(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 11.

Romania: Financial Soundness Indicators, 2008–10

(In percent)

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Source: Romanian National Bank.

NPLs for 2004-June 2009 include un-adjusted exposures of loans and related interests classified “loss” (overdue by more than 90 days, including the contaminated ones, and/or with for which legal proceedings were initiated) and from September 2009 the “NPLs ratio” represents un-adjusted exposures of loans and related interests classified “loss 2”, meaning loans and related interests overdue for more than 90 days and/or for which legal proceedings were initiated.

Return on equity is calculated as Net profit/loss to average own capital.

Liquid asets = balance sheet assets and off balance sheets items with residual maturity of up to 3 months

Short term liabilities =balance sheet liabilities and off balance sheet items with residual maturity of up to 3 months

Tier 1 Capital to average assets

Table 12a.

Romania: Schedule of Reviews and Purchases

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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 12b.

Romania: Schedule of Reviews and Purchases

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Source: IMF staff estimates.
Table 13.

Romania: Indicators of Fund Credit, 2011–16 1/

(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 March 2, 2011.

End of period.

Repayment schedule based on repurchase obligations.

Table 14.

Romania: Public Sector Debt Sustainability Framework, 2006-2016

(In percent of GDP, unless otherwise indicated)

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Coverage: General government gross debt, excluding guarantees.

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 15.

Romania: External Debt Sustainability Framework, 2006-2016

(In percent of GDP, unless otherwise indicated)

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e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

Derived as [r - g - ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ= change in domestic GDP deflator in uro 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. p 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.

C. Program Monitoring and Conditionality

39. The program will be monitored by quarterly reviews. Table 3 sets out specific quarterly targets that are to be observed under the SBA for the overall general government balance, guarantees provided by the general government, the change in arrears for the central government and social security system, CPI inflation, and net foreign assets. In addition, there will be indicative targets on the current primary expenditure of the general government, and the operating balances and arrears of SOEs. One prior action and structural benchmarks are presented in Table 4. The first review should be completed by end-June 2011 (based on end-March 2011 targets), and the second review by end-September 2011 (based on end-June 2011 targets).

40. Progress has been made by the NBR on the recommendations contained in the safeguards assessment performed under the May 2009 SBA. To evaluate this progress, the National Bank’s external auditors are authorized to provide IMF staff with all necessary information and to discuss directly any issues relevant to this process. The authorities also commit to receiving a safeguards mission and to provide that mission with all necessary information requested without delay. The safeguards assessment update should be completed by the time of the first review of the SBA (end-June, 2011).

Exceptional Access Criteria

Staff’s evaluation is that Romania continues to meet the four exceptional access criteria. Proposed access under the new SBA would equal €3.6 billion (SDR 3,090.6 million, 300 percent of quota). However, the overall access by Romania to the Fund’s general resources (net of scheduled purchases) exceeds normal access, requiring evaluation under the exceptional access framework. In staff’s view, Romania meets the four substantive exceptional access criteria:

  • Criterion 1—The member is experiencing or has the potential to experience exceptional balance of payments pressures on the current account or the capital account resulting in a need for Fund financing that cannot be met within the normal limits.

    Romania does not face actual balance of payments pressures. However, it is exposed to risks of economic and financial disruptions in Europe. The realization of a stress scenario14 could give rise to financing needs, which would imply cumulative access above the normal access limits.

  • Criterion 2—A rigorous and systematic analysis indicates that there is a high probability that the member’s public debt is sustainable in the medium term. However, in cases where there are significant uncertainties that make it difficult to state categorically that there is a high probability that debt is sustainable over this period, exceptional access would be justified if there is a high risk of international systemic spillovers.

    Public debt is low (33 percent of GDP) and is not expected to pose a risk under the program and in the medium term. Continued fiscal adjustment would set the public debt ratio firmly on a downward path, ensuring debt sustainability with a high probability. Barring unexpected events, potential contingent liabilities of the government would also be limited. Total external debt has risen to 75 percent of GDP in 2010 and is expected to peak at 79 percent in 2011. Starting from 2012, repayments to the Fund, a manageable current account deficit, and higher economic growth would gradually reduce the external debt in the medium-term.

  • Criterion 3—The member has prospects of gaining or regaining access to private capital markets within the timeframe when Fund resources are outstanding.

    Romania has regained access to private capital markets and is expected to retain access while Fund resources are outstanding. Early in 2010, a €1 billion Eurobond issue was successfully placed and domestic issuance of euro-denominated instruments totaling €2.4 billion were placed in July and November. Starting from 2011, the government will initiate the medium-term notes (MTN) program which is expected to generate around €2 to €2.5 billion a year for the next four years. However, elevated risks in the euro area may hamper the projected inflows through the MTN program.

  • Criterion 4—The policy program provides a reasonably strong prospect of success, including not only the member’s adjustment plans but also its institutional and political capacity to deliver that adjustment.

    The program has good prospects for success and will enhance Romania’s economic sustainability. The authorities’ performance during the current program lends confidence in their institutional and political capacity to continue implementing sound policies.

VI. Staff Appraisal

41. Romania’s economy has stabilized, and strong economic policies under the existing SBA have set the stage for renewed economic growth. Exchange rate volatility has eased without significant NBR intervention and country risk (as measured by CDS spreads) has lessened significantly. The current account deficit has been reduced sharply and exports are booming. Banking sector difficulties have been largely avoided and massive capital outflows have been forestalled. After significant challenges early in the program, government revenues are now overperforming, putting the government on track to reach its 2011 fiscal deficit without significant additional measures. While the economic recovery was delayed by weak domestic demand (in part due to the needed fiscal consolidation), GDP growth has now resumed and should gain strength in the coming quarters.

42. While fiscal adjustment measures already taken have placed Romania on a path toward its medium-term fiscal objectives, significant fiscal challenges remain:

  • The necessary revenue measures to address massive fiscal imbalances have left the country with high rates collected on a relatively narrow tax base, due to tax evasion, a large informal sector, and inefficiencies in tax administration. Over time, tax administration improvements must be implemented to allow for a gradual reduction in rates as the tax base expands.

  • Temporary cuts in public sector wages and across-the-board cuts in public employment were essential components in the adjustment strategy, but they must give way in the medium-term to application of the new unified wage system, together with comprehensive efforts to improve government efficiency based on the recent functional reviews.

  • Significant pressures remain in the health care sector, where further reforms are required to provide for efficient services within budget constraints and to avoid further arrears accumulation.

  • Successful efforts to clear payments arrears in the central government and social security system must be expanded to tackling the persistent arrears problems in local governments and public enterprises.

  • A large share of GDP is devoted to public investment in Romania, but the results are poor. Many projects are left uncompleted for years, completed projects are often overly expensive, and scarce domestic resources are used while grant money from the EU remains largely untapped.

These fiscal reforms are more complex than tax increases or broad expenditure cuts, making implementation of planned measures challenging but nonetheless essential.

43. Sustainable economic growth will require reforms in key economic sectors that are currently plagued by underperforming state firms functioning in conditions where market forces are not fully operational. The new program includes urgently needed reforms in the energy market and transport sectors aimed at an improved pricing framework and providing more independent and transparent regulation. An enhanced market environment in these sectors is a precondition for attracting private investment and managerial know-how, including in the search for strategic investors for SOEs. Staff encourages the authorities to reconsider their plan to form two national energy “champions” (combining viable and less efficient companies) in favor of a more aggressive privatization strategy for current firms. The authorities should also forcefully re-launch their privatization strategy outside the energy sector as well, selling majority stakes where appropriate. For those firms remaining under state control, enhanced monitoring and strengthened governance are also key steps to reverse operating losses and mounting arrears, which are a major fiscal and economic drag. The staff supports the authorities’ intention to reforms the labor market to ensure that the labor force is productive, flexible, and competitive while protecting workers and their collective bargaining rights.

44. The authorities’ strongly proactive stance in banking supervision has played a vital role in forestalling banking sector difficulties, but continued vigilance is needed. With NPLs expected to continue to rise for at least several months more—risks remain. These may need to be watched particularly carefully in smaller locally-owned banks without the prospect of parent support. The authorities should continue to elaborate detailed contingency plans in case of difficulties, as well as to develop procedures to use their newly enhanced bank resolution powers so as to be fully prepared in the event a bank was to face problems. Staff supports the authorities’ intention to extend the EBCI agreement while gradually reducing banks’ exposure commitments. Both the authorities and the banks have noted benefits from the initiative begun in Vienna in March 2009.

45. Monetary policy has appropriately balanced the need for a firm stance against inflation with the desire to support economic recovery. However, unforeseen pressures in food and energy prices, as well as needed changes in administered prices, may put the 2011 inflation target at risk. The authorities should step-up open market operations to mop up excess liquidity and bring interbank interest rates more in line with the policy rate. Once interbank interest rates are more in line with the policy rate, the NBR may see room for some additional rate cuts or reductions in reserve requirements if second round inflation effects remain absent. However, some differential between reserve requirement in local currency and FX should be maintained to help discourage excessive FX credit growth. The NBR should also avoid letting considerations of its own balance sheet unduly affect its monetary policy decisions.

46. On the basis of Romania’s performance under the SBA, staff supports the authorities’ requests for completion of the seventh review and for approval of a new arrangement. All seventh review performance criteria were met, with the exception of the end-December 2010 criterion on the general government arrears, for which a waiver has already been approved in the context of the last review. Progress on structural benchmarks has also been sufficient to merit completion of the review. Staff views the new SBA as an effective mechanism to insure against possible future shocks while aiding the authorities in maintaining policy discipline in their efforts to reach their fiscal consolidation objectives while undertaking deeper economic reforms. Given a normalization of Romania’s access to external financing in private markets, in the absence of further shocks the authorities would not likely need to draw under the arrangement despite repayments under the existing arrangement which begin in 2012.

The New Stand-By Arrangement

Access: SDR 3,090.6 million, 300 percent of quota.

Length: 24 months.

Phasing: Resources will be made available at 131 percent of quota in 2011 and 169 percent of quota in 2012 and 13. For the first year, disbursements would be 6 percent of quota upon approval of the arrangement followed by 3 equal installments (of 41.7 percent of quota) beginning with the first quarterly review (scheduled for June 2011).

Conditionality

  • Quantitative Performance Criteria

    • A floor on the change in net foreign assets

    • A ceiling on central government and social security domestic arrears

    • A floor on the overall general government cash balance

    • A ceiling on general government guarantees

    • Non-accumulation of external debt arrears

  • Quantitative Indicative Targets

    • A ceiling on general government current primary spending

    • A ceiling on local government domestic arrears

    • A floor on the operating balance and arrears of the key loss-making SOEs

  • A consultation band around the 12-month rate of inflation of consumer prices

  • Prior Action

    • Passage of indirect audit methods

  • Structural Benchmarks

    • Completion of a stocktaking of arrears and unpaid bills as of end-December 2010 for the entire general government and SOEs April 30, 2011

    • Preparation of strategic action plans for key SOEs (as specified in TMU) April 30, 2011

    • Elimination of the legal basis of stimulente funds, effective January 1, 2012 June 30, 2011

    • Introduction of a simplified taxation system for smaller taxpayers under the threshold with help from the IMF and EC, while requesting a shift in the VAT mandatory threshold from the EU Council of Ministers to €50,000 June 30, 2011

    • Completion of a comprehensive review of the existing investment portfolio, which will prioritize and evaluate existing projects to focus on those where funding can be fully secured, examine the viability of old projects, with low priority and unviable ones discontinued, and production of a final report and an action plan September 30, 2011

Figure 1.
Figure 1.

Romania: Recent Economic Trends

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

Source: Haver: Staff Estimates.
Figure 2.
Figure 2.

Romania: Financial Developments

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

Source: Bloomberg; Haver.
Figure 3.
Figure 3.

Romania: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shades. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2010. with real depreciation defined as nominal depredation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).
Figure 4.
Figure 4.

Romania: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2011, 080; 10.5089/9781455230075.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.3/ One-time real depreciation of 30 percent occurs in 2010.
1

A waiver for the end-December arrears target was granted January 7, 2011.

2

Under Eurostat rules, an SOE must be included as part of the general government when more than half of its resources come from the state over a three year period. Several Romanian firms fall within this threshold and will be folded into the general government statistics in the course of 2011.

3

According to a recent World Bank study conducted with PricewaterhouseCoopers, Romania ranks 151st out of 183 countries in terms of the ease of paying taxes, and 182nd in the number of payments required. See Paying Taxes 2011: The Global Picture, Washington, DC: The World Bank, 2010.

4

Indirect audit methods are crucial step toward improving tax administration. Among other things, they should help with the new initiative on high net wealth individual taxation.

5

For local government SOEs, the stocktaking of arrears and unpaid bills as of end-December will be completed by end-June 2011.

6

In 2010, the ten largest loss-making SOEs lost an estimated 1.1 percent of GDP in 2010.

7

Petrom already has a private majority shareholder; the state would sell an additional tranche of some 10 percent.

8

In 2010, the authorities launched a strategy to combine 21 existing state-owned energy production companies into two “national champion” firms. Among the concerns about such a strategy are the following: (i) it may create greater monopoly power within the Romanian market; (ii) the combination of profitable and loss-making firms may give rise to cross-subsidization, which is economically inefficient and may contravene EU regulations; and (iii) existing private minority shareholders in some energy firms have filed legal challenges to the mergers which may stall needed investment in the industry.

9

Using the authorities preferred definition of non-performing loans based upon 90 days past due. The ratio based upon doubtful and loss which includes 60 days past due rose to 20.8 percent.

10

The reserve requirements are 25 percent for foreign currency liabilities and 15 percent for local currency liabilities, including both short-term and long-term (with clauses referring to early withdrawal, repayment and transfer).

11

Romania has a large spread for interbank market rates (400 basis points around the policy rate, where the upper bound is the Lombard rate and the lower bound is the overnight standing facility), allowing for greater fluctuations of the interbank rate. Heavy reliance on the overnight standing facility has allowed the interbank rate to come closer to the lower end of the band. In recent weeks, the gap between interbank rates and the policy rate has been narrowing, suggesting a tightening of liquidity conditions.

12

The NFA target assumes the program is precautionary, and official inflows are represented accordingly.

13

Relative to the baseline, banks’ and corporations’ average rollover rates would decline by around 10 ppts.

14

The stress scenario involves reduced capitals inflows, and net exports resulting in lower growth, all of which together would create a financing gap in the balance of payments.

APPENDIX I: Romania: Letter of Intent

Bucharest, March 10, 2011

Mr. Dominique Strauss-Kahn

Managing Director

International Monetary Fund

Washington, DC 20431

Dear Mr. Strauss-Kahn:

1. Our anti-crisis program, supported by the International Monetary Fund (IMF), the European Union (EU), and the World Bank (WB), has continued to play a crucial role in stabilizing the Romanian economy, reversing imbalances, rebuilding confidence of international financial markets, and setting the stage for future sustainable economic growth. The economy has stabilized and is expected to recover in 2011 with around 1½ percent growth, due to continued strong exports, supported by gradually improving domestic demand, underpinned by planned improvements in absorption of EU funds. Inflation, driven by the recent VAT rate hike and high food and fuel prices, peaked at 8.0 percent at end-2010. During the course of 2011, inflation is expected to return to the NBR’s target band. The current account deficit has shrunk considerably from 11.6 percent in 2008 to around 4.5 percent in 2010. Despite these improvements, recovery remains vulnerable to adverse developments in international financial markets, via rising risk premia and lower capital inflows, and downside risks to euro area recovery.

2. In view of our strong performance under the macroeconomic program supported by the Stand-By Arrangement (SBA), the Government of Romania and the National Bank of Romania (NBR) request completion of the seventh review under the SBA. We are considering treating as precautionary the final purchase available upon completion of this review. Given that the current SBA with the IMF (approved on May 4, 2009) has been successful in achieving its broad objective of realizing macroeconomic stability in the face of crisis, we would also like to end the current SBA – and request the simultaneous approval of a new 24-month SBA totaling SDR 3,090.6 million (€3.5 billion, 300 percent of quota). The new SBA will support our comprehensive economic program for 2011–12 to boost sustainable economic growth, continue adjustment, and cushion the effects of future shocks, should they materialize. Since Romania’s international reserves position is comfortable and access to external financing is improving, our intention is to treat the new arrangement as precautionary. In conjunction with WB commitments of €400 million, and precautionary support of €1.4 billion under the EU’s balance of payment financing facility, this arrangement will signal the international community’s continued support for our policies.

3. We believe that the policies and measures set forth in this Letter are adequate to achieve the objectives of our macroeconomic program supported by the next SBA, but the Government and NBR stand ready to take additional measures as appropriate to ensure the achievement of its objectives. Romania will consult with the Fund on the adoption of measures that may become appropriate to achieve the objectives of the program, and in advance of revisions to the policies contained in this Letter, in accordance with the Fund’s policies on such consultation. We will also provide the IMF and the European Commission (EC) with the necessary information for program monitoring.

I. Performance under The Current SBA

Seventh Review

4. Our performance for the seventh review of the SBA has been strong (Table 1 and 2).

  • Quantitative performance criteria and indicative targets. The end-2010 fiscal deficit target was met with a margin of ¼ percent of GDP, reflecting higher revenues than anticipated. The NFA targets for end-December and end-January were also met with significant margins. All other remaining end-December 2010 quantitative performance criteria were observed, with the exception of that on general government arrears for which a waiver was already granted on January 7, 2011. The indicative targets on loss-making state-owned enterprises and current spending were missed. Inflation remained within the inner band of the inflation consultation mechanism throughout the period.

  • Structural benchmarks. The ordinance on high net wealth individuals was approved by end-December, as programmed. A full project plan to implement the integration of the accounting reporting system with the Treasury payment system is in place. We will shortly secure parliamentary ratification of the remaining amendments to the bank resolution framework, slightly delayed from the December 1, 2010. We will amend by ordinance the Deposit Guarantee Fund (DGF) law by end-July 2011 to allow for the use of resources administered by the DGF (including through guarantees) to facilitate restructuring measures authorized by the National Bank of Romania regarding the transfer of deposits, including purchase and assumption transactions, if such use would be less costly than the direct payment of deposit guarantees (structural benchmark reset from March).

Review of Existing Program

5. Significant progress has been made under the existing program in achieving fiscal consolidation and safeguarding the financial sector. A structural fiscal deficit of almost 9 percent of GDP in 2008, which aggravated the initial impact of the global financial crisis, was halved by 2010. Measures taken in 2010 have also put the government finances firmly on path to reach the Maastricht deficit target in 2012. Financial sector measures ensured adequate capitalization of banks and liquidity in domestic markets, securing banking sector stability. Excessive capital outflows were avoided, in part reflecting the European Bank Coordination Initiative, and an orderly adjustment of the current account was made possible without excessive exchange rate volatility. Structural reforms in tax administration, pensions, public wages and employment, and social benefits have placed public finances on a more sustainable medium-term path and have set the stage for more widespread improvements in the business climate.

II. Objectives and Policies for The New SBA

6. Romania is poised to reap the benefits of the difficult adjustment measures implemented under the existing program. The new economic program aims to boost potential growth with a focus on structural reforms, while consolidating fiscal and financial stability. In this context, building on the significant achievements of the current SBA, the key objectives of the new program are to: (i) continue the fiscal adjustment process while extending its scope to attack problems of revenue and expenditure efficiency and arrears; (ii) continue fostering confidence, facilitating improved private capital flows and generating sustainable growth; (iii) boost growth potential through structural reforms and improved flexibility of the economy, which will also allow for continued competitiveness as Romania prepares to eventually join the Euro area.

Macroeconomic Framework for 2011–12

7. After suffering a severe downturn in 2009-10, there are signs that economic activity is picking up. From around 1½ percent in 2011, growth is expected to gain momentum in 2012, reaching 4 to 4½ percent. Domestic demand will gradually become the main growth engine, supported by better absorption of EU funds. Growth in net external demand will slow in line with moderate growth of export markets, stabilizing the current account balance at around 5 percent of GDP. Increased investor confidence, coupled with planned privatization under the program, will bring renewed FDI and banking inflows.

Fiscal Policy

8. For 2011, we are committed to the previously agreed cash fiscal deficit target of 4.4 percent of GDP (or within 5 percent in ESA terms). We have passed the 2011 budget in line with our previous commitments. On the revenue side, the main components of the tax system will remain unchanged. We will request technical assistance from the IMF and WB to provide us with a comprehensive review of the tax system with a view toward revenue- neutral tax simplification. Should the economic recovery create sufficient fiscal space, we will consider a gradual reduction in social contributions, the high incidence of which weighs heavily on competitiveness, employment creation, and labor market practices. On the spending side, the wage bill will be kept within the agreed limit, as a nominal wage increase is balanced by elimination of the thirteenth salary and the holiday bonus. We have also maintained a freeze in the pension point. Public employment reductions will continue with the policy of replacing only 1 of 7 departing workers on average across the public sector. We remain committed to the implementation of the recently approved wage and pension reform legislation, which will generate significant savings in the coming years, while at the same time protecting the viability of the second pension pillar. Following recent action to incorporate stimulente into base wage, we will eliminate by government ordinance the legal basis of stimulente funds effective January 1, 2012 (structural benchmark end-June). To encourage tax collection efforts, performance bonuses may be granted to tax collectors within the 30 percent bonus limit (as defined in the implementing legislation) for sustained improvements in revenues. Further savings have been secured through the overhaul of the social assistance system. By end-July, we will improve the legislation to provide heating allowances to target the most vulnerable members of society, while generating significant savings for the budget. Health (¶14 and 15) and education reforms will continue to improve quality and generate savings. Within the budget envelope, we have allocated additional resources to investment in the first half of the year, so as to improve absorption of EU funds. If absorption improves sufficiently, we will work on solutions to create greater fiscal space for investment from mid-2011. In addition, we will implement a reporting system for the state-owned enterprises (SOEs) that have been recently added (or will be added in 2011) to the ESA definition of the general government.1 Once we start receiving timely information, at the time of the next review, we will request that the performance criterion on general government overall balance be amended to add the deficit of these entities.

9. For 2012, we aim to bring the deficit down to within 3 percent of GDP (in both cash and ESA terms). This will require compliance with the fiscal responsibility law and continued expenditure restraint, including on the wage bill. We will strictly limit further ad hoc changes to the tax system to ensure predictability and stability. We have started preparing the medium-term Fiscal Strategy for 2012–14, an important step in implementing the Fiscal Responsibility legislation, and will use this process to improve budget planning and solidify our commitment to the Maastricht targets. We will strengthen the recently established Fiscal Council, by providing it with adequate funding, so as to ensure that it is fully staffed with appropriately skilled people.

10. We will conduct a stocktaking of arrears and unpaid bills as of end-December 2010 for the entire general government and SOEs (structural benchmark, end-April 20112). This exercise will ensure that they provide the Ministry of Public Finance (MOPF) with details of all arrears and unpaid bills incurred as of end-20103, with no payments subsequently authorized for any bills not registered in this exercise. We will also develop an action plan by end-April 2011, including an improved commitment control mechanism and enforcement measures, to eliminate existing arrears and prevent the accumulation of new ones at both the general government level and SOEs. Over the next two years the period for paying bills after submission will be reduced. A forthcoming EU directive in this area will be transposed into Romanian law on a timely basis. At the central level, we have recently reduced arrears substantially and will keep state and social security sector arrears near zero as agreed previously (performance criterion). New legislation on local government finance that took effect on January 1, 2011 will also allow for greater control of local government arrears, for which an indicative target will be established. The first phase in the integration of the accounting reporting system with the Treasury payment system is complete (structural benchmark, March 15, 2011). The next phase, the design of the system, including the commitment control and reporting module for all levels of government, will be completed by end-September 2011.

11. We have improved our financing strategy and will continue to focus on extending the maturity of our domestic debt, building the yield curve, and consolidating the financial buffers, guided by the recently prepared debt management strategy, which will be updated and published annually. We are launching a “euro medium-term notes” program that will maintain our presence in the external markets under more flexible issuance procedures and will help us balance the financing between the domestic and external markets. We are firmly committed to raising financial buffers to around four months of financing needs during 2011 and maintaining them there. To enhance our capabilities, in 2011 we will conduct a formal review of our debt management strategy with the assistance of IMF, EC, and WB experts. We will also improve treasury information technology (IT) systems and strengthen senior staffing.

12. We will continue our efforts to improve tax administration and fight tax evasion. The ordinance relating to high net wealth individuals was approved by end-December 2010, meeting the structural benchmark. An IMF expert has assisted in its subsequent implementation. We will staff the newly created Individual Analysis Office by end-March and develop and implement a compliance risk strategy in accordance with best practices by August 2011. Separately, the government decision on indirect audit methods will be passed (prior action), and we will develop an organizational strategy and implementation plan for incorporating these methods into our compliance functions by June 2011. As agreed with the IMF and EC, we will institute simplified taxation for smaller taxpayers under the threshold with help from the IMF and EC, while requesting a shift in the VAT mandatory threshold from the EU Council of Ministers to EUR 50,000 (structural benchmark, end-June 2011). We have unified several tax forms on social contributions starting this year. We are planning further simplification of tax forms and the number of payments required with a view to providing a one-stop shop for tax payments and expansion of e-filing. We will continue our efforts to introduce IT systems and consolidate the IT department in ANAF to improve tax administration. We have also started preparing the ANAF restructuring plan and will have a draft submitted to Parliament by end-April 2011. We will also provide a central point for screening and referral of potential cases of tax fraud and strengthen guidelines for identification of tax fraud.

13. The accelerated absorption of EU funds remains a focal objective of the government. Over the coming year, we will focus on strengthening the administrative capacity of units managing the funds; modernizing and consolidating the legislative and regulatory framework for public investment and other fields relevant for EU fund absorption; and prioritizing investment to assure sufficient financing for key projects. The government will also move the EU structural funds coordination unit from the MOPF to the Prime Minister’s office and strengthen its authority and staffing. We will conduct a comprehensive review of the existing investment portfolio (including EU and non-EU funded projects), which will prioritize and evaluate the existing portfolio of projects to focus on those where funding can be fully secured within a medium-term horizon (e.g., 3-5 years), examine the viability of old projects, with low priority and non-performing ones discontinued, and will produce a database by June and a final report and an action plan by end-September 2011 (structural benchmark). We will create facilities for reallocating the capital budget during the year to those ministries with the best EU funds absorption performance and a track record of efficient project implementation.

14. The government will continue restructuring the health sector to ensure the quality functioning of the health care system within budgetary allocations going forward. We have reduced health payment arrears by end-December 2010 and continue implementing measures in line with our previous commitments. To achieve an appropriate balance between the need to preserve adequate healthcare services and to control costs, we have submitted legislation establishing a copayment system to Parliament; limited the number of contracted hospital in-patients by 10 percent relative to the 2010 levels; reduced the price markup paid by the government for drugs in the national programs (list C2); reduced the share of per-capita reimbursement of doctors from 70 to 50 percent. We are implementing a transparent and integrated IT system in the health sector to monitor and increase efficiency of health spending, where a significant number of questionable claims have already been uncovered. We have also asked the Court of Accounts to audit registrations of patients in primary care.

15. The following health sector measures agreed previously are currently under preparation: (i) clarifying the legislative framework for the claw back tax on drug suppliers; (ii) restructuring the hospital system; (iii) eliminating mandatory contracting with all hospitals, allowing competitive contracting with selected hospitals while ensuring transparency and oversight; (iv) providing indicative caps for quarterly services contracted with hospitals and physicians with the development of incentives for physicians who remain within the ceilings; and (v) reforming, with assistance from the WB, the package of benefits insured by the government to exclude coverage of costly nonessential health services. We will also analyze and revise, with the assistance of the WB, the formula for the National Health House by the introduction of a mechanism whereby “money follows the patient.” We will revise the list of compensated and free drugs approved by government decision 720/08, with a view toward modifying the list of these drugs and wherever possible moving to generics. For 2012, pharmaceutical costs of the most expensive drugs will be further controlled by applying strict drug use protocols and a new electronic prescription module for the National Health Information System, following strict procedures. Lastly, we will review hospital budgets and start implementing the hospital rationalization strategy with the objective of reducing the number of financed hospital beds (currently 135,200) to the EU per capita average by 2013, while also adapting acute beds accordingly. To reach this objective, by end-June 2011 we will reduce the number of beds to 133,000, and 129,500 by end-December 2011.

Financial Sector

16. The rise in non-performing loans slowed significantly during the final quarter of 2010, reaching 11.9 percent of total loans of the banking sector. As the economic recovery gains ground, and loan loss provisions stabilize over the first half of 2011, the banking sector as a whole is expected to return to profitability. The banks remain well capitalized, at 14.7percent, with all banks posting a solvency ratio above 11 percent at the end of 2010. The parents of the largest foreign subsidiaries maintained aggregate exposures under the European Bank Coordination Initiative (EBCI) at 98 percent at end-January 2011, well above the new target of 95 percent of end-March 2009 exposure. We intend to pursue discussions on an extension of the EBCI agreement, with a view toward gradually easing exposure commitments from banks as international market conditions improve.

17. We will maintain close vigilance over developments in the banking sector and continue to strengthen the financial safety net. The NBR, in conjunction with the DGF, will develop procedures for deploying the new restructuring powers, and will prepare contingency plans. We will also ensure that the DGF has ready access to liquidity to meet any potential shortfalls in funding, and to develop joint procedures, as agreed with the MOPF, for accessing the funds if necessary to help preserve depositor confidence and financial stability. The authorities will take the necessary measures to ensure that consolidation in the banking sector will deliver strong and well capitalized institutions with a shareholder base that can support them. The authorities will review the DGF, banking and the winding-up legislation to ensure their mutual consistency. To facilitate better bank access to NBR liquidity, the NBR will widen the range of assets acceptable as collateral for its refinancing operations to bonds issued locally by international financial institutions which are listed at the Bucharest Stock Exchange, as well as Eurobonds issued by the Government.

18. The NBR will prepare and release for consultation by end-June 2011 proposals for prudential filters that would preserve prudent bank solvency, provisions, and reserves, and enable the timely introduction of IFRS at the beginning of 2012. The authorities will ensure that the prudential treatment of debt-for-equity swaps does not result in a weakening of banks’ financial positions4 and impose requirements for banks to have in place methodologies for valuing the equity at the lowest value applicable according to the accounting treatment. We will monitor developments in foreign currency lending and take steps as needed to ensure that foreign currency credit is appropriately priced in order to reflect the risk of lending in foreign exchange to un-hedged borrowers. We will continue to consult with the IMF and EC staff before introducing or amending other aspects of the regulatory framework and make efforts to avoid adopting legislative initiatives, such as the current draft of the personal insolvency law or proposals for the debt collecting law, which could undermine debtor discipline. The current in-house banking executors shall have the possibility to join the liberal profession of public judicial executors without any formal restrictions and entry barriers such as professional admission licensing and/or exams as well as admission fees or taxes of any kind, and they shall become members of the above profession with full professional guarantees, rights, and obligations.

Monetary and Exchange Rate Policy

19. The NBR remains committed to bring inflation down to within the official target band of 3 percent ± 1 percentage point in 2011 and 2012. As under the existing program, progress towards these goals will be monitored using an inflation consultation clause (see TMU). The effects of last July’s VAT rate increase on inflation have been roughly as expected. However, inflation in recent months was further boosted by food and fuel price pressures. After peaking around 8 percent, headline inflation is expected to gradually return to the NBR’s target band in the second half of 2011. While existing slack in the economy would foster disinflation, risks are tilted to the upside, as food and energy prices may rise by more than expected and forthcoming SOE reforms may require increases in administered prices. Monetary policy easing may be resumed during 2011 provided major risks do not materialize and inflation remains close to the projected path.

20. Under the program, we anticipate increases in Gross International Reserves in 2011 (mostly reflecting multilateral disbursements) and 2012. They will provide improved confidence in the economy and allow for greater reserve coverage of short-term foreign liabilities. A performance criterion will be established on Net Foreign Assets that is consistent with this projection for gross reserves accumulation. Reserve losses exceeding €2 billion in any 30-day period during the program will trigger consultation with IMF staff.

21. During the period of the SBA we will not, without Fund approval, introduce or intensify restrictions on the making of payments and transfers for current international transactions, nor introduce or modify any multiple currency practices or conclude any bilateral payment agreements that are inconsistent with Article VIII of the IMF’s Articles of Agreement. Moreover, we will not introduce or intensify import restrictions for balance of payments reasons.

Growth and Flexibility Enhancing Structural Reforms
State-Owned Enterprises

22. We are committed to deep-rooted reform of state-owned enterprises (SOEs), especially in critical growth generating sectors such as energy and transport. In recent years, many SOEs have become an increasingly substantial fiscal burden. In addition to requiring subsidies to cover considerable losses, they have accumulated arrears of more than 4 percent of GDP. The quality of service in many sectors is in need of significant improvements and weighs on growth by hindering further private sector development.

23. Implementing a comprehensive strategy addressing the viability of SOEs and reforming their governance will be vital. We will develop strategic action plans5 by end-April 2011 for key firms (as specified in ¶20 of the TMU, structural benchmark) and end-July 2011 for all other firms that: (i) provides up-to-date information on the financial viability of each SOE with majority government ownership, and each regii autonome (autonomous institution, AI); (ii) classifies each as being in line for either liquidation, privatization, or retention (with restructuring as needed), (iii) outlines the steps to achieve closure, viability, or privatization; and (iv) lays out concrete plans to substantially reduce arrears (e.g. through payback, securitizations, swaps, etc.). We will implement a system to report main financial and economic indicators of all SOEs and AIs to the MOPF on a monthly basis. We will also amend ordinance 79/2008 to require that AIs and enterprises subordinated to local governments submit quarterly key financial and operational indicators to the MOPF. For key privatizations (¶25, 26)6, an internationally recognized transaction advisor will be appointed by end-August 2011, proposals submitted by end-2011, and tenders made by mid-2012. To address problems in SOE governance, we will develop (in consultation with the WB) and approve legislation to improve governance in these firms, to require regular independent external audits, and to move financial control of SOEs from line ministries to the MOPF by end-September 2011.

24. Securing efficient energy provision is crucial for sustainable growth. The energy sector suffers from underinvestment due to the effects of the economic downturn, the dominance of undercapitalized state-owned firms with room for efficiency improvements, and the fact that adjustments have not been fully applied in regulated prices and tariffs (due to concerns about effects on consumers). To address pricing and regulatory deficiencies, we will: (i) take the necessary steps to restore the energy regulator’s (ANRE) operational and financial autonomy in accordance with EU legislation (third energy package); (ii) present a roadmap for phasing out regulated prices in electricity and gas by September 2011; (iii) define the vulnerable consumers by end-2011 according to EU legislation and develop mechanisms to protect them (in conjunction with the Ministries of Finance and Labor); (iv) complete removal, according to EU directives, of regulated prices for non-households in electricity and gas before end 20137 and complete the process by end-2015; and (v) assure that new bilateral contracts signed by state-owned gas and electricity generators be made transparently and non-discriminately through OPCOM (electricity) and other competitive procedures (gas), and that prices in existing contracts will be adjusted to prevailing market rates as quickly as legally permissible.

25. Much needed capital and managerial know-how will be brought to the energy sector through minority private investors (via IPOs or sales of stakes to strategic partners) in the following firms, with government approval: (i) Petrom (sale of a 10 percent stake is already underway); (ii) Transelectrica (15 percent stake by end-2011); (iii) Transgaz (15 percent stake by end-2011); and (iv) Romgaz (15 percent stake by spring 2012). If we succeed with our strategy to form the two national champion companies we will introduce appropriate mechanisms to ensure there is no cross-subsidization, in conjunction with recommendations of the Competition Council. If the national champion strategy is not successful by end-2011, we will look for an alternative solution, including by privatizing majority stakes in some energy firms. In the meantime, to bring investment into the sector we will move ahead to prepare sales of minority or strategic stakes in individual firms slated to be included in the national champion companies (which could later be converted to stakes in the combined firms).8 The tax administration, ANAF, will use continued enforcement procedures on the tax arrears of CNH, which will ultimately lead to the selling of viable assets, possibly applying insolvency procedures. Remaining coal assets will be liquidated in line with EU stated rules. In Termoelectrica, viable assets will be separated and the remaining operations closed.

26. Private sector growth is severely constrained by inadequate transportation infrastructure. Addressing this weakness will lower production costs, improve export possibilities, and make Romania a more attractive destination for investment. Full execution of Ministry of Transport investment plans (particularly those with EU co-financing) will be crucial (¶13). Following EU rules on state aid, state-owned transport firms must also be privatized or restructured to provide needed service improvements. Actions will include the following:

Roads

  • CNADNR will boost its revenues in 2011 while eliminating or renegotiating non-performing contracts.

  • The Ministry of Transport will seek to balance road and rail transportation by reducing road transport.

Railways

  • We will extend the policy of standard costs in the railway system, particularly for railway infrastructure procurement and for repairing rolling stock. We will develop multi-annual plans for public procurement and investments in CFR Calatori and CFR Marfa, in line with transport and necessities programs and in connection with market evolution. In CFR Infrastructura, CFR Calatori and CFR Marfa we will continue to use fully depreciated assets. Restructured personnel will be provided with reintegration and training services.

  • Cargo- A minority stake in CFR Marfa will be offered in order to attract a strategic investor by end-2011 with a view toward a full privatization when market conditions permit.

  • Passenger- Efficiency of the passenger rail service will be increased through restructuring of CFR Calatori, including by modifying its passenger service contracts, better cost recovery (including allowing for higher tariffs), and significant reductions in its scope of service. A strategic plan will aim at a 15 percent reduction in losses and no accumulation of new arrears in 2011.

  • Infrastructure- Service reductions will also significantly improve the financial outlook for CFR Infrastructura. We will close 1000 kilometers of railway lines by end-August and will develop plans for competitive tendering of public service obligations and infrastructure maintenance on lines for another 20 percent of the system or close them. A strategic plan will aim at a 25 percent reduction in losses and no accumulation of new arrears in 2011.

Metropolitan transit

  • We will pass legislation to establish a new metropolitan transit authority that will oversee Metrorex together with the above ground public transport system in Bucharest (RATB). The law will also allow for greater tariff adjustments (beyond inflation-indexing) in line with the strategic plan of covering current expenditures through revenues and capital expenditures through subsidies. Metrorex will diminish maintenance costs by 30 percent by end 2011.

Air transport

  • We will complete an analysis for Tarom by end-April 2011, with a view toward seeking a strategic investor.

Labor Markets

27. We are making important legislative changes to increase the flexibility of the labor market, improve the efficiency of collective bargaining (while protecting the rights of workers and employers), and increasing labor force participation. We have finalized a draft law on amending the labor code and are processing the social dialogue code, which will consolidate the laws on trade unions, labor conflict resolution, employer association, collective labor contract, and Economic and Social Council. Both the amended labor code and the social dialogue code are expected to be approved by Parliament in the coming months. In addition, we will request that the International Labor Organization conduct a review of labor inspections to improve enforcement and address the large informal labor market in Romania. Improving the efficiency of social protection will remain a priority, especially in the area of social inspection.

Business Climate

28. Designed to improve the business climate, structural reforms in this program are growth-promoting. Infrastructure investment and efficiency will be boosted both from greater absorption of EU structural funds (¶13) and the restructuring, closing, or privatization of SOEs, especially in energy and transport (¶22–26). More broadly, steps to reduce tax compliance costs (¶12) and improve governance, as well as public procurement and contracting reforms, will reduce bureaucratic costs and impediments for the private sector. We will also undertake reforms in the agriculture sector—including by speeding up the surveying and registration of agricultural land—to improve food security and increase export prospects. We will work together with the EU to address concerns regarding the new public private partnership law.

Program Monitoring

29. The program will be monitored through quantitative performance criteria and indicative targets, structural benchmarks and consultation clauses, during quarterly reviews. Table 3 sets out specific quarterly targets that are to be observed under the SBA for the overall general government balance, guarantees provided by the general government, the change in arrears for the central government and social security system, CPI inflation, and net foreign assets. In addition, there will be indicative targets on the current primary expenditure of the general government, the operating balances and arrears of SOEs. We have also agreed with Fund staff on a prior action and structural benchmarks in Table 4. The first review should be completed by end-June, 2011, and the second review by end-September, 2011.

Safeguards

30. Progress has been made by the NBR on the recommendations contained in the safeguards assessment performed under the May 2009 SBA. To evaluate this progress, we will authorize the National Bank’s external auditors to provide IMF staff with all necessary information and to discuss directly with them any issues relevant to this process. We also commit to receiving a safeguards mission, and to provide that mission with all necessary information requested without delay. The safeguards assessment update should be completed by the time of the first review of the SBA end-June, 2011.

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Attachments

Table 1.

Romania: Quantitative Program Targets for Seventh Review

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The December 2008 figure is a stock.

Performance criterion for January 2011 and indicative target for March 2011 are relative to December 2010 target.

Cumulative figure during calendar year (e.g. March 2011 figure is cumulative from January 1, 2011).

In accordance with TMU, the end-September and end-December program targets were adjusted from the original target of -28,200 and -34,650 by one-half of the revenue over-performance.

The target for March 2011 can be adjusted with higher or lower capital spending as defined in TMU.

Table 2.

Romania: Performance for Seventh Review

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Table 3.

Romania: Quantitative Program Targets for New Program

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The end-December 2010 figure is a stock.

Cumulative flows relative to end-December 2010 stock.

Cumulative figure during calendar year (e.g. March 2011 figure is cumulative from January 1, 2011).

The target for March 2011 can be adjusted with higher or lower capital spending as defined in TMU.

Table 4.

Romania: Conditionality for New Program

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Notes
1

Specifically, we will require monthly cash revenues, expenditures, and overdue payment bills statements as well as final quarterly fiscal statements as provided by other general government entities within the same deadline.

2

For local government SOEs, the stocktaking of arrears and unpaid bills as of end-December will be completed by end-June 2011.

3

If required, the data will be verified with the help of external audit teams.

4

The prudential treatment of debt-for-equity swaps should guarantee that: (i) the involvement of credit institutions in such operations unfolds on the basis of a prudent decision making process; (ii) the value of equity is fully deducted from the own funds of credit institutions to avoid an artificial improvement in prudential indicators; and (iii) the revenues obtained by releasing loan-loss provisions due to these operations are not taxed.

5

The strategic action plans will be reviewed by the WB.

6

In addition to those listed below, we will begin analysis for privatization of the governments remaining stake in Oltchim.

7

By April 1, 2011 a calendar will be established for adjustments to reach the full Unitary Gas Cost (CUG) price formula by end-2011 for non-residential consumers.

8

Among the firms slated to be included in the national champions where strategic investments will be sought are the energy complexes in Craiova, Turceni, and Rovinari.

APPENDIX II. Romania: Technical Memorandum of Understanding (TMU)

March 10, 2011

31. This Technical Memorandum of Understanding (TMU) defines the variables included in the quantitative performance criteria and indicative targets set out in the letter of intent (LOI), the key assumptions, methods to be applied in assessing program performance, and the reporting requirements to ensure adequate monitoring of economic and financial developments. The quantitative performance criteria and indicative targets, and structural benchmarks for 2011 are listed in Tables 3 and 4 of the LOI, respectively.

2. For the purposes of the program, the exchange rates of the Romanian Leu (RON) to the euro is set at RON 4.2848 = €1, to the U.S. dollar at RON 3.2045 = $1, to the Japanese yen at RON 3.9400 = ¥100, and to the pound sterling at RON 4.9673 = £1, the rates as shown on the National Bank of Romania’s (NBR’s) website as of December 31, 2010. The exchange rates to other currencies, where applicable, will also be the ones shown on the NBR’s website as of December 31, 2010.

3. For the purposes of the program, the general government includes the entities as defined in the 2011 budget. These are: the central government (state budget, treasury, self- financed state entities included in the budget, etc.), local governments, social security funds (pension, health, and unemployment), road fund company, and administration of the property fund. This definition of general government also includes any new funds, or other special budgetary and extra budgetary programs that may be created during the program period to carry out operations of a fiscal nature as defined in the IMF’s Manual on Government Finance Statistics 2001. The authorities will inform IMF staff of the creation of any such new funds or programs immediately. As mentioned in the LOI (¶8), this definition will be expanded at the time of the first review under the SBA to cover state-owned enterprises incorporated into the general government accounts under ESA.

Quantitative Performance Criteria, Indicative Targets, Inflation Consultation Band, and Continuous Performance Criteria

A. Floor on the Change in Net Foreign Assets

4. For program purposes, Net Foreign Assets (NFA) are defined as the NFA of the NBR minus Treasury liabilities to the International Monetary Fund.

5. NFA of the NBR are defined as the euro value of gross foreign assets of the NBR (including reserve requirements of the commercial banking system held at the NBR) minus gross foreign liabilities of the NBR; and will be measured on the basis of the NBR’s operational rather than accounting definitions. Non-euro denominated foreign assets and liabilities will be converted into euro at the program exchange rates.

6. Gross foreign assets of the NBR are defined to include the NBR’s holdings of SDRs, the country’s reserve position at the IMF, holdings of cash, securities and deposits abroad in convertible foreign currencies. Excluded from reserve assets are: (i) gold and other precious metals; (ii) assets in nonconvertible currencies; (iii) illiquid assets; (iv) any assets that are pledged, collateralized, or otherwise encumbered, unless there is also a gross foreign liability associated with it; (v) claims on residents; and (vi) claims in foreign exchange arising from derivatives in foreign currencies vis-à-vis domestic currency (such as futures, forwards, swaps, and options).

7. Gross foreign liabilities of the NBR are defined as all foreign exchange liabilities to residents and nonresidents, including commitments to sell foreign exchange arising from derivatives (such as futures, forwards, swaps, and options), and all credit outstanding from the IMF, but excluding (i) banks’ foreign currency deposits against reserve requirements; and (ii) government foreign currency deposits at the NBR. This definition is meant to bring the concept of foreign liabilities closer to the balance of payment definition, on which the targets are based.

Floor on cumulative change in NFA from the beginning of the year

(in mln. euros)1

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PC = performance criterion; data for end-month. Flows in 2011 are cumulative from the beginning of the calendar year (e.g., March 2011 figure is cumulative from January 1, 2011). The 2011 stocks are obtained by adding 2011 flows to end-2010 stock.

8. NFA targets will be adjusted upward (downward) by the surplus (shortfall) in program disbursements relative to the baseline projection. Program disbursements are defined as external disbursements from official creditors (World Bank and the EC) that are usable for the financing of the overall central government budget. The NFA targets will also be adjusted upward by the increase in commercial bank reserve requirements held with the NBR relative to end-December, 2010 (€6,797 million), measured at program exchange rates.

External program disbursements–Baseline projections

(in mln. euros)

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B. Consultation Mechanism on the 12-month Rate of Inflation

9. The quarterly consultation bands for the 12-month rate of inflation in consumer prices (as measured by the headline consumer price index (CPI) published by the Romanian Statistical Institute), are specified below. Should the observed year-on-year rate of CPI inflation fall outside the outer bands specified below, the authorities will complete a consultation with the IMF on their proposed policy response before requesting further purchases under the program. In addition, the NBR will conduct discussions with IMF staff should the observed year-on-year rate of CPI inflation fall outside the inner bands specified for the end of each quarter in the table above.

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C. Performance Criterion on General Government Balance

10. The budget deficit will be monitored quarterly through the cash balance of the general government. The authorities will consult with IMF staff on corrective measures in the event of shortfalls in government revenue and financing.

Cumulative floor on general government balance1

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Cumulative figure during calendar year (e.g., March 2011 figure is cumulative from January 1, 2011).

11. The budget deficit will be measured from above the line using the budget execution data. At the time of the first review the calculation of the 2011 budget deficit will be modified to be in line with the expanded definition of the general government which will include the following SOEs (the data is expected to become available at the end of 2011Q1)1: Compania Nationala a Huilei S.A., Compania Nationala de Atostrazi si Drumari Nationale, Fondul Proprietatea, Metrorex S.A., Regia Autonoma Administratia Fluviala a Dunarii de Jos Galati, Societatea Nationala a Carbunelui S.A., Societatea Nationala de Transport Feroviar de Calatori, Compania Nationala de Radiocomunicatii Navale Radio Constanta, Societatea Nationala de Transport Feroviar de Infrastructura, Termoelectrica S.A., Acvavalor S.A., Aeroportul Arad S.A., Aeroportul Iasi RA, Aeroportul International Baia Mare R.A., Aeroportul Satu Mare R.A., Aeroportul Stefan Cel Mare Suceava R.A., Aeroportul Transilvania – Tirgu Mures R.A., Aeroportul Tulcea, Aqua Calor S.A., Centrala Electrica de Termoficare Brasov S.A., Citadin S.A. Hundedoara, Dalkia Romania S.R.L., Edil Therma Hunedoara, Goscomloc S.A., Gospodarie Oraseneasca S.A., Rominservices Therm S.A., Societatea Nationala “Aeroportul International Mihail Kogalniceanu”, T.S.P Ecoterm S.A., Termica S.A., Termloc S.A., Uzina Termica Comanesti S.A.

12. The Ministry of Public Finance (MOPF) will also provide monthly data to measure the deficit from below the line. The balance of the general government measured from below the line will include:

  • + (i) net external financing, excluding valuation gains and losses;

  • + (ii) change in net domestic credit from the financial system, excluding valuation gains and losses from deposits denominated in foreign currency and including adjustments for;

    • + (a) received EU funds not yet spent (advance payments);

    • + (b) claims of the government on EU funds;

    • + (c) property fund obligations not yet paid;

  • + (iii) change in the stock of issued government securities, net of valuation changes;

  • + (iv) net changes in other financing.

13. If the difference between the general government deficit measured from above the line and from below the line is larger than lei 200 million each quarter during 2011, the MOPF will consult with IMF staff.

14. In the event that non-grant revenues exceed those projected under the program, the deficit target will be adjusted downward by one half of the surplus to allow for additional capital spending while reducing the deficit further. The following table shows the accumulated projected non-grant revenue for 2011, to which the actual non-grant revenue will be compared.

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Cumulative figure during calendar year (e.g., March 2011 figure is cumulative from January 1, 2011).

15. The performance criterion for the general government balance for the first quarter of 2011 will be adjusted downward from -6,300 by the amount that capital spending (including EU funds-related spending) exceeds 5,740 million lei, up to a limit of -8,000 million. Likewise, the target will be adjusted upward by the amount that capital spending undershoots 5,740 million lei in the first quarter of 2011.

D. Performance Criterion Limiting the Issuance of Government Guarantees to the Non-Financial Private Sector and Public Enterprises

The issuance of general government guarantees to the non-financial private sector and public enterprises will be limited during the program period. This ceiling is set at RON 14 billion but may be adjusted upward by up to RON 9.6 billion for guarantees for financing the Nabucco project. Revision to targets will be renegotiated during future missions to allow for reasonable public guarantees in the context of privatization of majority stakes in state- owned enterprises and securitization of domestic payment arrears.

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E. Performance Criterion on the Stock of Domestic Arrears by the Central Government and Social Security System

17. The performance criterion established on the stock in domestic payments arrears of the central government and social security sector (as defined in ¶3 above) contemplates their elimination during the program period. The stock will be measured net of intergovernmental arrears, but both gross and net arrears will be reported by the government. In case of need, the government will take corrective measures to prevent the accumulation of new spending arrears. For the purpose of the program, arrears mean accounts payable past due date by 90 days (in line with ESA95 definitions for expenditures).

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F. Continuous Performance Criteria on Non-Accumulation of External Payments Arrears by the General Government

18. The general government will not accumulate external payment arrears during the program period. For the purposes of this performance criterion, an external payment arrear will be defined as a payment by the general government which has not been made within seven days of falling due. The performance criterion will apply on a continuous basis.

G. Indicative Target on General Government Current Primary Spending

The indicative target on current primary expenditure of the general government is defined as spending on personnel, goods and services excluding EU funds (specified under external grant category), subsidies, transfers to public entities, pensions (social security budget in social assistance category), state aid and other spending in other transfers category, Reserve Fund, and other expenditure as classified in the monthly reporting tables. The current spending target will be adjusted for the extra spending due to swap arrangement between local governments and public enterprises by an amount spent in the respective quarter.1

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Cumulative figure during calendar year (e.g., March 2011 figure is cumulative from January 1, 2011).

H. Indicative Target on Local Government Arrears

20. The indicative target on the stock of domestic payments arrears of local governments contemplates no accumulation of new arrears and their reduction during the program period. In case of need, the government will take corrective measures to prevent the accumulation of new spending arrears. For the purpose of the program, arrears mean accounts payable past due date by 90 days (in line with ESA95 definitions for expenditures).

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I. Monitoring of Public Enterprises

21. A quarterly indicative target for 2011 is set on the aggregate operating balance (earnings before interest and tax) net of subsidies, accumulated per calendar year, of the following public enterprises: C.N. Căi Ferate CFR S.A., C.N. de Autostrãzi de Drumuri Naţionale din România S.A., C.N. a Huilei S.A., C.N. Poşta Românã S.A., S.C. Complexul Energetic Turceni S.A., S.C. Filiala de Intreţinere şi Servicii Energetice “Electrica Serv” - S.A., S.C. Metrorex S.A., S.N. de Transport Feroviar de Marfă “CFR Marfă” S.A., S.N. Transport Feroviar de Călători “CFR Călători” S.A., C.N. Tarom S.A., S.C. Electrocentrale Bucureşti S.A., S.C. Electrica Furnizare Transilvania Nord S.A., S.C. Oltchim S.A., S.C. Termoelectrica S.A., SNa Lignitului Oltenia S.A., S.C. Electrificare CFR S.A., S. C. Intervenţii Feroviare S.A., S. C. Telecomunicaţii C.F.R. S.A. The data shall be reported with operating results by firm. The targets will be as follows:

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Cumulative figure during calendar year (e.g., March 2011 figure is cumulative from January 1, 2011).

22. A quarterly indicative target for 2011 is set on the stock of arrears of the public enterprises listed in ¶21 above. The data shall be reported at the firm level. The targets will be as follows:

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23. The quarterly indicative targets for the aggregate operating balance (¶21) and stock of arrears (¶22) for the public enterprises listed in ¶21 above will be revised at the time of the first review in accordance with the actions plans and audited end-2010 data (both of which will be available at that time).

J. Reporting Requirements

24. Performance under the program will be monitored from data supplied to the IMF by the NBR and the MOPF as outlined in the table below. The authorities will transmit promptly to IMF staff any data revisions as well as other information necessary to monitor the arrangement with the IMF.

Romania: Data Provision to the IMF

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1

The list of SOEs to be included in the definition of general government will be determined by Eurostat at end-March, including possible revisions to those SOEs already incorporated.

1

The swap arrangement would involve mutually cancelling overdue tax obligations of public enterprises with arrears owed to those enterprises by the general government (local administration).

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Cover IMF Staff Country Reports
Romania: Seventh Review Under the Stand-By Arrangement Cancellation of Current Stand-By Arrangement and Request for a New Stand-By Arrangement-Staff Report; Supplement on the Assessment of the Risks to the Fund and the Fund's Liquidity Position; Supplementary Information; Press Release on the Executive Board Discussion; Statement by the Executive Director and the Senior Advisor to the Executive Director for Romania
Author:
International Monetary Fund
Volume/Issue:
Volume 2011: Issue 080
Publisher:
International Monetary Fund
ISBN:
9781455230075
ISSN:
1934-7685
Pages:
101
DOI:
https://doi.org/10.5089/9781455230075.002

Industrial Production

Private consumption and retail trade

National Currency per Euro

(July 1, 2008 = 100)

CDS, 5-years

Exports (SA), Imports (SA), Trade balance 12m

(billion Euros)

INFLATION TARGETS AND OUTCOMES

General Government Arrears and Unpaid Bills

(bn RON)

Public Sector Employment

(in Millions, end of period)

154 SOEs: Arrears and personnel, 2008–10

154 SOEs: Revenues, expenditures, subsidies & profit, 2008–10, bn. lei

MONETARY CONDITIONS INDEX 1/

INTEREST RATES

ON RON INSTRUMENTS

(in percent)
Figure 1.

Romania: Recent Economic Trends
Figure 2.

Romania: Financial Developments
Figure 3.

Romania: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)
Figure 4.

Romania: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)