Statement by Mr. Age Bakker, Executive Director for Romania and Mr. Mihai Tanasescu, Senior Advisor to the Executive Director

Although the economic growth of Romania has resumed, it has boosted downside risks. However, the country has continued its strong performance under the new program in strengthening macroeconomic policies, accelerating structural reforms, and consolidating economic development. In conclusion, the authorities concur that the current precautionary Stand-By Arrangement (SBA) will provide additional security against unforeseen shocks, thereby setting the stage for strong and sustainable economic development while maintaining external and internal stability and thereby achieving the fiscal goals for 2012.

Abstract

Although the economic growth of Romania has resumed, it has boosted downside risks. However, the country has continued its strong performance under the new program in strengthening macroeconomic policies, accelerating structural reforms, and consolidating economic development. In conclusion, the authorities concur that the current precautionary Stand-By Arrangement (SBA) will provide additional security against unforeseen shocks, thereby setting the stage for strong and sustainable economic development while maintaining external and internal stability and thereby achieving the fiscal goals for 2012.

The economic programs supported by the Fund, the European Union, and the World Bank played an important role in stabilizing the Romanian economy, generating concrete results in boosting growth and maintaining fiscal and financial stability. The current precautionary Stand-By Arrangement, approved in March 2011, aims at strengthening macroeconomic policies, accelerating structural reforms, and consolidating economic development.

Romania has continued its strong performance under the new program. All performance criteria for the second review were met, and all indicative targets, except the one on SOE arrears, have been met.

Recent Economic Developments

Economic growth has resumed, and Romania posted the third consecutive quarter of positive growth in the second quarter of 2011. Growth remained modest in the second quarter and slipped to 0.2 percent (q/q), but continued good performance of industrial output and a good harvest are expected to contribute to a rise of 1.5 percent for 2011 as a whole. GDP growth is expected to further accelerate in 2012 to around 3 percent, but downside risks have risen, due to uncertainties in the international environment and challenges in absorbing EU investment funds.

The inflation rate has dropped sharply in the last three months and reached 4.3 percent at end-August, from its peak of 8.4 percent in May, reflecting a large decline in food prices and the elimination of the first-round effect of the 2010 VAT increase from the 12-month index. We expect inflation to continue to decline, and the latest developments indicate that the NBR’s 2011 inflation target is likely to be met.

The external position improved significantly. The current account deficit reached 4.1 percent of GDP in 2010, and is projected to stabilize at a similar level in 2011 and remain below 5 percent of GDP in 2012.

In July, Fitch upgraded Romania’s long-term foreign currency rating to investment grade, and the leu appreciated somewhat by 3 percent against the euro. Due to the recent turbulence in international markets, these gains have been reversed and CDS spreads have risen apace with other economies in the region. On a positive note, international reserves remained comfortable at nearly 35 billion euro, covering more than 100 percent of the short-term debt at residual maturity.

Despite the progress achieved, the recovery remains vulnerable to adverse developments in international markets and weaker than expected growth in Western Europe. Spillovers from the ongoing turbulence in the euro area could further dampen exports and affect capital flows to Romania through the banking system. The authorities will remain vigilant, act proactively, and take the necessary steps to contain these risks.

Fiscal Policy

The fiscal package implemented since the beginning of the previous program in 2009 has produced the targeted adjustment and put the fiscal stance on the right path. For 2011, the authorities are on track to meet the cash fiscal deficit target of 4.4 percent of GDP. For 2012, the authorities maintain their commitment to bring down the deficit to less than 3 percent of GDP. The preliminary budget preparation is based on a cash deficit of 2.8 percent of GDP. However, the current international environment, together with Eurostat’s decision to add additional SOEs into the general government definition, could add another 0.3 percent of GDP to the deficit, which will make it challenging to reach the authorities’ commitment to the European Commission of a fiscal deficit of 3 percent of GDP in accrual (ESA) terms. The Romanian authorities are fully committed to continue fiscal consolidation and to take the necessary steps, including continued expenditure restraint, to achieve their commitments.

On the expenditure side, the authorities will keep the wage bill within the agreed limit and take additional measures to secure the 2011 deficit target, including by continuing to rationalize public employment. The authorities will continue efforts to improve and prioritize capital spending in order to increase the absorption of EU funds. Efforts are underway to strengthen the administrative capacity of units managing European funds, and the recent decision to create the Ministry of European Affairs will accelerate this process. On health care reform, the authorities will implement a comprehensive package of measures to address the structural deficits of the healthcare system, which will include the introduction of copayments for medical service, creating a supplementary insurance contribution, and revising and simplifying the clawback tax on pharmaceuticals.

On the revenue side, tax policies will remain largely unchanged, including the VAT rate, which will be kept at 24 percent. With the technical assistance of the Fund, the authorities will review the tax code by the end of the year to close tax loopholes and improve its efficiency. Under the current program, improving tax administration and fighting tax evasion are crucial elements to increase revenue. The authorities already approved important measures, including a plan to promote the use of indirect audit methods in order to assess tax liabilities, and restructuring and closing 141 regional tax offices. Proposals to introduce a simplified tax regime for small taxpayers, to improve the VAT refund process, and to expand auditing of large taxpayers are underway.

To continue the fiscal consolidation path, the authorities are committed to decrease the stock of arrears. Arrears and unpaid bills of the general government have been declining since the beginning of the program. However, challenges remain in state-owned enterprises, where the arrears have stabilized in the second quarter of 2011. Additional efforts are needed to continue reducing them. In this context, the authorities have prepared a series of schemes to clear SOE arrears via netting arrangements, debt swaps, recapitalization of firms, arrears securitization, and government lending.

Monetary and Financial Sector Policies

The monetary authorities responded appropriately to the contraction in economic activity, and the Central Bank has taken important measures to bring down inflation. Despite high inflation earlier in the year, the Central Bank did not see an immediate need for an increase in policy rates, but the authorities remain concerned about upside risks stemming from expected increases in administered prices. Recently, the inflation rate dropped sharply to 4.3 percent at end-August. As we expect inflation to continue to decline, the Central Bank’s 2011 inflation target is likely to be met. In light of gathering risks of contagion from financial disturbances in the region and possible capital outflows, the authorities will remain vigilant against inflation risks and remains committed to take action as needed to assure achievement of its 2012 inflation target.

The Romanian financial system so far has weathered well the impact of the economic downturn of the past two years. The banking system remains well capitalized, with an average solvency ratio of 14.2 percent and a core tier 1 ratio of 13.6%. The rise of non-performing loans slowed over the last quarter, and bank lending to the corporate sector picked up, but real growth remained negative on an annual basis. A key role for keeping the financial sector in good health has been played by the European Bank Coordination Initiative which enabled the parent banks of the nine largest foreign-owned banks operating in Romania to keep their long-term capital exposure commitments to the country and consolidate capital levels. However, due to the recent international market turbulence, the level of exposure fell from 98 percent at end-March to 95 percent of the level when the initiative commenced. The Central Bank remains vigilant to weaknesses in the banking system and stands ready to provide liquidity as necessary to mitigate segmentation in the interbank market. It is also refining its full range of contingency measures to be deployed if necessary to preserve depositor confidence.

Progress continues to be made on the regulatory front, and the authorities are finalizing the regulatory framework and tax treatment for filters for provisioning that will preserve the current prudent approach once International Financial Reporting Standards are introduced for banks at the beginning of 2012. Significant progress has been made in finalizing the outstanding benchmark to enable the Deposit Guarantee Fund to finance the new bank resolution.

Structural Reforms

Under the current program the authorities are committed to deep-rooted reform of the stateowned enterprises (SOE), especially in the transport and energy sectors, to enable sustainable economic growth and better competitiveness. The authorities made progress in the reform agenda, and measures have been implemented for 18 key SOEs, contributing to achieving the second quarter indicative target on the operating balance of these companies. They have finalized action plans for many of the 154 companies, and implemented the necessary measures to improve their efficiency. Progress is also being achieved in the privatization process, and despite the recent unsuccessful offering of an additional 9.8 percent stake in Petrom, the authorities remain committed to the agreed calendar for privatizing minority stakes in other firms, and will reoffer the Petrom shares in a market-friendly process in early 2012. To improve governance of the SOEs, the authorities will develop and approve legislation requiring all SOEs to have regular independent external audits, to report and publish financial data quarterly, and to move financial control of SOEs from line ministries to the Ministry of Public Finance.

In the transport sector, the authorities continued to implement measures to cut expenditures and raise revenues. In the rail sector they implemented standard costs for infrastructure procurement and maintenance of rolling stock. In order to bring the rail sector closer to economic viability, the authorities will continue the process of closing 1000 kilometers of rail lines. Personnel cuts have been approved and are to a large extent already implemented. In order to increase revenues, the authorities prepared the legal basis for tariff adjustments for metropolitan transit and passenger rail and raised rates by 18 percent.

In the energy sector, the authorities will take the necessary steps to restore the energy regulator’s operational and financial autonomy in accordance with EU legislation. The regulator will also continue to adjust prices for gas and electricity for non-residential consumers (on September 22, 2011 they increased gas prices by 8 percent), moving to world prices by end-2013. For households, adjustments will be more gradual, with the process completed by end-2015. The coal companies will continue to be downsized by forming separate legal entities and splitting viable and non-viable assets. The viable assets will later be privatized and non-viable assets will be liquidated in line with EU rules. For attracting more private investment, the authorities decided to pursue an alternative energy strategy with smaller energy companies, including the partial privatization of a number of them.

In conclusion, my authorities concur that the current precautionary Stand-By Arrangement will maintain the reform momentum, provide additional security against unforeseen shocks, and build on the considerable progress achieved over the past two years, thereby setting the stage for strong and sustainable economic development while maintaining external and internal stability.

Romania: Second Review under the Stand-By Arrangement and Request for Modification of Performance Criteria-Staff Report; Staff Supplement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Romania.
Author: International Monetary Fund