Growth in Romania is likely to moderate in 2012, weighed down by the euro area slowdown. The Fifth Review Under the Stand-By Arrangement highlights that Romania’s overall track record under the program continues to be strong. All performance criteria for the fifth program review were met, except for accumulation of central government arrears, which was missed by a small margin. The indicative target on local government arrears accumulation was also missed. Progress was made on the large and difficult structural agenda, although more action is needed.
The economic program, supported by the Fund, European Commission, 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. Romania’s performance under the current program continues to be strong, and all performance criteria for the fifth review were met, except for the one on accumulation of central government arrears, which was missed by a small margin. The authorities continue their efforts on accomplishing the goals of a large structural agenda, with a focus on reforming the healthcare sector and state-owned enterprises.
Recent economic developments
Romania’s economic recovery continues. Real GDP grew by 2.5 percent in 2011 on the back of a very good harvest and thanks to a recovery in private demand, but it declined by 0.2 percent in the fourth quarter (q/q) and by 0.1 percent in the first quarter of 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 the financial market turbulence, but overall, the 2012 growth is expected to reach around 1.5 percent. Growth will be driven by a recovery in domestic demand and by a better absorption of EU funds.
The inflation rate has dropped sharply to a record low of 1.8 percent in May as a result of continued food price deflation, which offset growth in administrative and oil prices. We expect inflation to gradually climb in the second half of the year, while remaining within the central bank’s target band of 3 plus/minus 1 percent.
The external position improved significantly. The current account deficit is expected to be around 4.5 percent of GDP for 2012, stabilizing at around 4.5-5 percent of GDP thereafter. In 2012, net exports are expected to remain stable, and official transfers are projected to recover, as EU fund absorption picks up.
Public debt financing has been positive so far this year. On the external side, the authorities succeeded in issuing US 2.25 billion in 10-year dollar-denominated bonds in January and February at a favorable rate. On the local market, they continued to build the lei yield curve and to extend the maturity of domestic debt, including with the launch of a domestic bond with 15 year maturity.
Despite the progress achieved, recovery remains vulnerable to adverse developments in international markets, weaker-than-expected growth in Western Europe, and further bank deleveraging. Spillovers from the ongoing turbulence in the euro area could dampen exports and affect capital flows to Romania. The authorities will remain vigilant, act proactively, and take the necessary steps to contain these risks.
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 consolidation process will continue. The fiscal target in 2012 is lower than in 2011 by more than 2 percentage points of GDP in structural terms; it is set to be reduced to 2.8 percent in ESA terms. Since the first program started, Romania improved its fiscal stance by more than 7 percent of GDP, and the authorities remain committed to continue this process in 2013. Under the new fiscal strategy, implementing further structural adjustments, the deficit target in 2013 is set to be at 2.2 percent in ESA terms. Moreover, to achieve this goal the authorities are committed to continue restraining expenditures and prioritizing investment projects with a focus on the EU-funded initiatives. They will also improve tax collection by implementing measures to simplify the tax code and strengthen the tax audit and enforcement efforts, based on the technical assistance recommendations from the Fund.
The authorities proposed relaxing the program’s cash deficit target in 2012 by 0.3 percent of GDP, while remaining committed to bringing down the fiscal deficit in ESA terms below 3 percent of GDP, as agreed under the EU Excessive Deficit Procedure. Using the additional space under the new cash deficit, the authorities will implement a wage increase of 8 percent beginning in June 2012, with the remainder of the 2010 cuts restoration to be implemented in December, if budget conditions permit. Personnel spending will remain at 6.7 percent of GDP in 2012, unchanged from 2011, reflecting the continued strong decline in public employment.
After a year of declining arrears and unpaid bills in the general government, arrears increased in early 2012 to 0.2 percent of GDP, concentrated mostly in local governments. These developments necessitated an allocation by the authorities of additional transfers from the central government to help reduce these arrears. At the same time, the authorities will seek technical assistance to evaluate the implementation of the Local Public Finance Law and the financial arrangements for local governments to avoid accumulating future arrears. In SOEs monitored under the program, arrears in the first quarter of 2012 stood below the indicative target, and the authorities anticipate that by implementing additional measures, the arrears will be reduced by more than 1 percent of GDP in the second half of 2012.
In the health sector, arrears in registered bills with the Health Insurance Fund have been eliminated, but arrears in hospitals have been rising. The recently introduced claw-back tax will be fully used to pay down the arrears and to implement key measures, including revising the copayment formula and better control expenditures by introducing a negative list of health services and drugs. This will decrease sharply the stock of arrears accumulated in the health care system.
Monetary and financial sector policies
The monetary authorities responded appropriately to economic developments, and the central bank has gradually and prudently reduced its policy rate amid abating inflationary pressures. Since November 2011, the central bank eased by a cumulative 100 basis points while maintaining the reserve requirements on local and FX currencies. Due to external uncertainties, the central bank decided in its May policy meeting to keep the interest rate unchanged, and has also been adding liquidity to the system through weekly repo auctions with banks. Lending and deposit rates for non-bank clients, as well as interbank rates, have reflected the cumulative reduction in the NBR policy rate.
Headline inflation fell to a record low of 1.8 percent in May as a result of food price deflation and declining nonfuel commodity prices. Core inflation continued to decline, reaching a low of 2 percent in March. 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, with the NBR forecast at 3.2 percent for December 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 are committed to taking action as needed to assure the 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-March 2012. Private sector credit has grown, with lending to the non-financial corporate sector up 10.8 percent and to households up by 4.9 percent in real terms at end-April. However, the NPLs ratio rose to 15.9 percent in March compared to 14.3 percent at end-2011. Total prudential provisions at end-March were sufficient to cover 99 percent of NPLs while the new IFRS provisioning ratio stood at a comfortable 68.4 percent. 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 the current tax disincentives, and will undergo an assessment by the World Bank of the arrangements for insolvency and creditor rights. In light of the current international vulnerabilities, the central bank remains vigilant to vulnerabilities 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 supervising the banking system and taking the necessary steps to ensure that banks have sufficient capital and liquidity.
Under the current program the authorities are committed to a 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 transport sector, the authorities are developing a new general transport master plan, which will balance the increasing demand and available fiscal means, ensure complementarities between different transport modes, and define priorities for the medium-and long-term investment. Recently, the government approved an emergency ordinance to grant a bridge loan to clear the CFR rail infrastructure arrears to private energy providers and issue a government memorandum for elimination of penalties and gradual payment of principal on arrears owed to Electrica. To increase efficiency of the sector, the authorities will focus on putting in place private management in CFR Cai Ferate and CFR Calatori, and to lease or close approximately 550 kilometers of lines. Moreover, major infrastructure projects using EU funds are advancing and revenues are increasing through tariff adjustments and enhancing toll collection. At the same time, privatization of the Tarom (IPO 20 percent) and CFR Marfa (majority privatization) this year remains a priority for the Romanian authorities.
In the energy sector, the authorities envisage major reforms, including a change in the national energy strategy with a view of attracting more private capital and allowing for a 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 gas prices for non-households, leading to full liberalization of this segment by January 2015. At the same time, the parliament approved legislation to transpose the EU Third Energy Package into the Romanian legislation. 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. In this context, they succeeded in selling a 15 percent stake in Transelectrica and will concentrate efforts in 2012 to sell shares in Hidroelectrica, Nuclearelectrica, Romgaz, and Transgaz. In addition, the authorities will continue their privatization efforts of a number of companies, including of the new energy producers, Hunedoara and Oltenia.
In conclusion, my authorities concur that the current precautionary Stand-By Arrangement will maintain the reform momentum, provide additional security against unforeseen risks, 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.