Statement by Mr. Menno Snel, Executive Director for Romania and Mr. Mihai Tanasescu, Senior Advisor to the Executive Director March 21, 2012

This paper discusses Romania’s fourth review under the Stand-By Arrangement and request for modification of performance criteria. The authorities are treating the arrangement as precautionary. Additional funds under the program are provided by the European Union. The economy grew by 2.5 percent in 2011, driven by an exceptional agricultural harvest and strong industrial output growth. Domestic demand strengthened as construction and retail sales started to recover, fuelled by higher real disposable incomes.


This paper discusses Romania’s fourth review under the Stand-By Arrangement and request for modification of performance criteria. The authorities are treating the arrangement as precautionary. Additional funds under the program are provided by the European Union. The economy grew by 2.5 percent in 2011, driven by an exceptional agricultural harvest and strong industrial output growth. Domestic demand strengthened as construction and retail sales started to recover, fuelled by higher real disposable incomes.

The program supported by the international financial institutions played an important role in stabilizing the Romanian economy, generating results in boosting growth and maintaining fiscal and financial stability. Romania’s performance under the current program remains strong, and all performance criteria and indicative targets for the fourth review were met. The authorities continue their efforts on a large structural agenda, with a focus on reforming the health care sector and state-owned enterprises.

Recent Economic Developments

Economic growth has resumed after two years of recession. As a whole, the economy grew in 2011 by 2.5 percent (up from 2 percent previously forecast), and is expected to continue on a positive path in 2012. However, 2012 economic growth is likely to be less robust than previously foreseen, reflecting mainly the deteriorating external environment in the euro area and spillover effects from financial market turbulence. Amid signs of a gradually improving labor market and the anticipated absorption of EU funds, 2012 growth is expected to be mainly driven by domestic demand, reaching around 1.5–2 percent.

The inflation rate has dropped sharply in recent months to 2.56 percent at end-February, reflecting a large decline in food prices and elimination of the first-round effect of the 2010 VAT increase. We expect inflation to remain below 3 percent in the first half of 2012, before gradually climbing, and to stay within the central bank’s target band of 3 plus/minus 1 percent.

The external position improved significantly. The current account deficit is projected to remain around 4–4.5 percent of GDP in 2012, stabilizing at 4.5-5 percent of GDP thereafter. In 2012, net exports are expected to remain stable as the projected recession in the euro zone should depress export growth while also leading to subdued import demand. FDI inflows are expected to remain depressed amidst the faltering economy in the euro area, but further privatizations could generate some recovery.

Taking advantage of favorable market conditions, in January the authorities successfully extended their Medium-Term Note program by issuing a US$ 1.5 billion 10 year dollar denominated Eurobond, and reopened the issue in late February for another US$ 750 million. The authorities will continue to build up their foreign currency buffers, including 1 billion Euros from the World Bank DPL-DDO financing, with a view to maintaining four months of gross financing needs. Moreover, they continue to build up the yield curve, including with the recent launch of a domestic bond with a 15 year 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. The 2011 cash deficit target was met with a significant margin and the expenditure savings were allocated to capital spending at the end of the year, including to clear arrears and unpaid bills in state-owned enterprises and the health sector. The 2012 budget is based on a cash deficit of 1.9 percent of GDP, well below 3 percent of GDP on ESA terms. Despite the downward revision in economic growth this year, higher than projected tax yields carried over from last year, together with lower expenditures, are expected to put this ambitious target within reach. Moreover, to achieve this goal, the authorities decided to freeze public wages and pensions and to continue reductions in public employment. To stimulate domestic demand, however, the authorities could later consider an increase in the wage bill, if economic conditions permit.

On the expenditure side, the authorities will continue efforts to improve and prioritize capital spending in order to increase the absorption of EU funds. The authorities approved a list of 100 EU-funded priority projects whose implementation will be strictly monitored. Savings in capital expenditures could come from the reduction in the national co-financing of EU-funded projects from 15 to 5 percent. On health care reform, the authorities will implement a comprehensive package of measures to address the structural deficits of the health care system, including having a revised draft framework by mid-year, which will enhance service quality over the medium term. A key element of the framework law will be to define a publicly provided basic healthcare package, with increased private sector involvement in healthcare provision and financing, such as through supplementary private insurance and private management of hospitals.

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 to close the tax loopholes and improve its efficiency. Crucial elements in the current program to increase revenue are improving the tax administration and fighting tax evasion. The authorities are making progress in the areas of organizational restructuring, administrative efficiency, risk assessment, taxpayer segmentation, and indirect and audit methods.

To continue the fiscal consolidation path, the authorities are committed to decreasing the stock of arrears. At the end of 2011 general government arrears amounted to less than 0.2 percent of GDP, mostly concentrated at the local government level, particularly in smaller communities. Stricter enforcement of the local public finance law will continue to reduce the stock of existing arrears. In the health sector, arrears in registered bills have been completely eliminated. Outside of the general government, arrears in state owned enterprises continued to be reduced, but additional efforts are needed.

Monetary and Financial Sector Policies

The monetary authorities responded appropriately to recent economic developments, and the central bank has gradually reduced its policy rate amid abating inflationary pressures. Since November 2011, the central bank eased by a cumulative 75 basis points, to 5.5 percent, while maintaining the reserve requirements on local and FX currencies. The impact of the rate cuts on the exchange rate and capital flows has so far been limited. However, upside risks remain, including additional adjustment of administered prices and a possible rebound of domestic food prices. Nonetheless, inflation is expected to stay within the central bank’s target band of 3 plus/minus 1 percent at end-2012. In light of the gathering risks of contagion from financial disturbances in the region and possible capital outflows, the monetary authorities will remain vigilant against inflation risks and committed to taking action as needed to assure achievement of the 2012 inflation target.

The Romanian financial sector so far has weathered well the impact of the economic challenges. The banking system remained well capitalized with an average capital adequacy ratio of 14.5 percent at end-December 2011 supported by new capital injections of RON 1.6 billion (about 400 million Euros). NPLs have stagnated at 14 percent at end-2011, and provisioning remains prudent, covering 99.5 percent of NPLs. To help mitigate the rise in impaired loans and improve the efficiency of bank balance sheets, the authorities will revise the tax treatment of bank loans sold to Romanian entities to remove current tax disincentives, and will undergo an assessment by the World Bank of the arrangements for insolvency and creditor rights. A key role in keeping the financial system in good health has been played by the European Bank Coordination Initiative. The aggregate exposure to Romania of the nine banks in the initiative stood at 101 percent of the March 2009 level, and even though they have not agreed on a specific target exposure level, going forward these banks have affirmed their long-term commitment to the country and continued to report exposures. In light of the current international vulnerabilities, 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. The central bank will continue to intensively supervise the banking system and take the necessary measures to ensure that banks have sufficient capital and liquidity.

On the regulatory front, the central bank continues to make progress in strengthening the institutional framework and operational preparedness of the financial safety net. In January 2012 amendments were adopted to the bank resolution legislation to introduce bridge bank and other stabilization powers for dealing with failing banks, as well as to strengthen arrangements to augment quickly the resources of the Deposit Guarantee Fund.

Structural Reforms

Under the current program the authorities are committed to deep-rooted reform of state owned enterprises, especially in the transport and energy sectors, to enable sustainable economic growth and better competitiveness. The authorities have made progress in the reform agenda, but challenges remain.

In the energy sector, the authorities envisage major reforms, including a change in the national energy strategy with a view to attracting more private capital and allowing more transparent, flexible, and competitive energy production and supply. To enhance the pricing and regulatory framework, the government approved a roadmap to gradually adjust regulated electricity prices for non-households, leading to full liberalization of this segment by January 2014. In the gas sector, the authorities aim to develop a roadmap for the deregulation of gas prices by April 2012. To address regulatory deficiencies, the government approved and submitted to parliament legislation to transpose the 3rd EU Energy Package, including the functional and financial independence of the energy regulator. Progress has been made on restructuring of the state-owned enterprises, and despite some delays the authorities remain committed to speeding up implementation and preparing several companies for privatization. The implementation of the new corporate governance law has commenced, and three companies will introduce private management this year.

In the transport sector, the authorities continued to implement measures to cut expenditures and raise revenues. In the rail sector, the government has made progress in closing underutilized rail lines and streamlining the operations in certain transport state-owned enterprises. Moreover, major infrastructure projects using EU funds are advancing and revenues are increasing through tariff adjustments and enhanced toll collection.

Ex Post Evaluation of Exceptional Access under the 2009 Stand By Arrangement

The 2008 financial crisis hit hard the Romanian economy, and created external and domestic imbalances, including a rapid increase in domestic private credit and associated asset bubbles. Given the severity of the problems, at the beginning of 2009 the authorities requested an SBA to restore market confidence by addressing the economic imbalances and, along with reforms, to achieve medium-term fiscal sustainability. The authorities fully agree that the SBA implementation demonstrated that the program was well designed, while appropriate reform prioritization was central to achieving the program objectives. The large and front-loaded financing along with upfront fiscal actions helped quickly restore market confidence, with a successful return to private financial markets during the program period. Thanks to the European Bank Coordination Initiative, the banking system weathered the crisis well, and foreign banks committed to maintaining their exposure to their Romanian subsidiaries and capitalize them as needed. The fiscal consolidation process together with a comprehensive structural agenda made it possible to achieve medium-term fiscal sustainability and improve fiscal institutions. Moreover, the structural reforms, such as the public wage reform, pension reform, labor market reform, state-owned enterprise reform helped to put Romania in a better medium-term fiscal position and boost potential growth. The authorities consider the first SBA to have been appropriate and the measures implemented have restored macroeconomic stability and achieved an orderly adjustment of pre-crisis imbalances. Last but not least, the program embodied successful cooperation between the EU and the Fund.

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

Romania: Fourth 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