Statement by Mr. Menno Snel, Executive Director for Romania and Mr. Serban Matei, Senior Advisor to the Executive Director, June 26, 2013

This paper discusses Romania’s Seventh and Eighth Reviews Under the Stand-by Arrangement and Request for Waiver of Nonobservance of Performance Criteria. Continued strong fiscal consolidation would enable Romania to exit the EU Excessive Deficit Procedure by mid-2013; prudent monetary policy kept core inflation low, and close supervision buttressed banking sector stability. Fiscal and international reserves buffers and a well-capitalized banking sector provide a cushion against shocks. Market sentiment toward Romania improved as political uncertainty subsided in the aftermath of the December 2012 parliamentary elections, which the ruling coalition won. Structural reforms, however, advanced slowly, and the recovery has lagged behind that in most other European emerging economies.


This paper discusses Romania’s Seventh and Eighth Reviews Under the Stand-by Arrangement and Request for Waiver of Nonobservance of Performance Criteria. Continued strong fiscal consolidation would enable Romania to exit the EU Excessive Deficit Procedure by mid-2013; prudent monetary policy kept core inflation low, and close supervision buttressed banking sector stability. Fiscal and international reserves buffers and a well-capitalized banking sector provide a cushion against shocks. Market sentiment toward Romania improved as political uncertainty subsided in the aftermath of the December 2012 parliamentary elections, which the ruling coalition won. Structural reforms, however, advanced slowly, and the recovery has lagged behind that in most other European emerging economies.

The economic program, supported by the Fund, the European Commission, and the World Bank, played an important role in stabilizing the Romanian economy, generating concrete results in maintaining growth and maintaining fiscal and financial stability. Romania’s performance under the current program continues to be strong. Extending the program by three months allowed the authorities to continue their efforts to reach the goals of a broad structural agenda, with a focus on structural reforms in the energy, transport and healthcare sectors and state-owned enterprises. Therefore, as of today all prior actions were met. Moreover, in line with their EU commitments, the authorities have reduced the fiscal deficit (in ESA terms) to below 3 percent of GDP in 2012, which allowed Romania to exit the EU Excessive Deficit Procedure.

Recent economic developments

Despite a slowdown in the second part of 2012, Romania’s economic recovery continues. Real GDP grew by 0.7 percent in 2012. Domestic demand slowed amid political uncertainty and the recession in the euro area dragged down exports. In addition, severe winter weather depressed activity in the first quarter and a drought led to a sharp contraction in agricultural production in the third quarter of 2012. Economic growth was less robust than foreseen, reflecting mainly the deteriorating external environment in the euro area and spillover effects from financial markets turbulence. However, a 2.2 percent annual growth during the first quarter of 2013 exceeded expectations.

The inflation rate picked up in the second half of the year on account of a supply-driven increase in volatile food prices, the pass-through of the depreciation of the exchange rate during May-September, and an increase in international commodity prices. Annual inflation came down to 5.3 percent in April. Taking into account the upside risks for the inflation outlook, the NBR has maintained the policy rate at 5.25 percent, while pro-actively adjusting liquidity conditions.

The external position has been consolidated. The current account deficit remained below 4 percent of GDP in 2012 and is expected to stabilize at this level in 2013 -2014. The deficit was financed mainly through issuance of sovereign Eurobonds, inflows from international financial institutions, and to a lesser extent foreign direct investments. Romania sold $2.25 billion in U.S. dollar denominated bonds and €2.25 billion in Eurobonds in 2012. The authorities continued to tap international markets in 2013, selling $1.5 billion in 10-year U.S. dollar-denominated bonds at a yield of 4.5 percent in February.

Despite the progress achieved, the recovery remains vulnerable to adverse developments in international markets, weaker-than-expected growth in Europe, and possibly more rapid and less orderly bank deleveraging. Spillovers from the 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. Therefore, continued firm policy implementation and maintenance of fiscal, external, and financial sector buffers to safeguard against risks are essential for the Romanian authorities.

Fiscal policy

Since the start of the first program, Romania significantly improved its fiscal position and the authorities remain committed to continue this process. In 2012, the fiscal deficit narrowed significantly, and estimates point to a deficit (in ESA terms) below 3 percent of GDP, allowing Romania to exit the EU’s Excessive Deficit Procedure.

Under the new fiscal strategy, implementing further structural adjustments, the 2013 budget targets a cash deficit of 2.1 percent of GDP. This is consistent with a reduction in the ESA structural deficit by 0.5 percent of GDP, in line with the commitments under the EU’s Stability and Growth Pact. Moreover, to achieve this goal, the authorities are committed to continue restraining expenditures and prioritizing investment projects with a focus on 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 and the World Bank. In addition, the World Bank has just approved a loan in April 2013 supporting the modernization of the tax administration and the strengthening of the revenue collection capacity. Fiscal performance through the first quarter of 2013 was in line with projections.

The government is undertaking measures towards eliminating central and local government arrears. Arrears at the central and local government levels declined from RON 1.5 billion at end-September to RON 868 million at end-December 2012 and arrears at the Health Insurance Fund were eliminated. The government took several measures, consistent with Fund advice, to reduce the stock of arrears to meet the initial program targets and prevent accumulation of new arrears. Although the end-December performance criterion for the central government was narrowly missed (mostly of hospitals) and the indicative target for the local government was missed, corrective action has been taken by the authorities. At end-May 2013 both central and local government arrears targets were met. The arrears of the SOEs monitored under the program at end-2012 stood at 2 percent of GDP, above the indicative program ceiling of 1.5 percent of GDP and the authorities anticipate that they will be further reduced in 2013.

Monetary policy

The monetary authorities responded appropriately to economic developments, and the central bank decided to keep the interest rate at 5.25 percent. Interbank rates increased and temporarily exceeded the policy rate towards the end of 2012 after the move to firm liquidity management. Interbank rates came down again from January, as the NBR resumed the adequate management of liquidity in the banking system. As a result of central bank action to counteract excess volatility in the exchange rate market, the exchange rate stabilized in mid-October, before appreciating by some 3 percent since end-November on account of improved investor appetite for Romanian assets, particularly government securities, following the inclusion of Romanian government bonds in the international global indices (JP Morgan and Barclay’s).

Sizeable capital movements and the continuation of the deleveraging process required NBR action to reduce exchange rate volatility. This process also resulted in the NFA target being missed at end-December, after taking into account the adjuster on issuance of government securities on external markets. The authorities took advantage of improved market sentiment to ensure an adequate international reserves buffer while making substantial repayments to the IMF. Liquidity conditions have eased since early 2013, owing inter alia to the NBR increasing and subsequently lifting the cap on repurchase operations in March. The interest rate corridor has been narrowed around the policy rate from ±4 percent to ±3 percent in order to moderate interest rate volatility on the interbank money market and to consolidate the transmission of the policy rate signal.

Headline inflation increased mainly on the back of higher food prices end 2012, following the poor harvest, and exceeded the NBR target band of 3±1 percent in December 2012. Inflation remained above 5 percent during the early months of 2013, due to base effects and increases in administered prices and excise duties, but is expected to gradually return to the upper end of the new target band of 2.5±1 percent in the second half of the year. Core inflation (HICP basis) dropped to 2.66 percent in May, and is expected to remain low throughout the rest of the year, mainly on account of the dissipation of pressures from food prices and the persistent negative output gap.

Risks associated with the inflation projections are balanced, with possible deviations on either side of the baseline scenario on account of higher volatility in international capital flows. This continues to warrant a prudent monetary policy stance supported by consistent implementation of the macroeconomic policy mix. The current monetary policy stance appears broadly appropriate but will be adjusted as needed to continue anchoring inflation expectations while also ensuring that international reserves are on an appropriate path.

Financial sector

The Romanian financial sector maintains reassuring capital buffers and provisions but faces continuing pressures on asset quality from deleveraging and spillovers from abroad. So far the Cyprus crisis had only a very limited impact on the banking system. Annual credit growth to both corporate and households has turned negative. Nonperforming loans (NPLs) rose to 19.1 percent in March 2013, driven mainly by the deterioration of the economic environment and tighter supervisory enforcement, compared to 14.3 percent at end-2011.

Total prudential provisions at end-March were sufficient to cover 102.6 percent of NPLs while the IFRS provisioning ratio stood at 78 percent. The NBR-mandated collateral audit resulted in a provisioning gap of around €600 million (around 1 percent of the total loan portfolio and partly due to the regular provisioning flow in the examination period), which has been fully closed. The capitalization of the banking sector remained strong at 15 percent at end-March 2013. Bank profitability remains poor with an overall system loss during 2012. The banking system turned a profit in the first quarter of 2013.

Structural reforms

Under the current program the authorities are committed to reforming the 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 continue with the implementation of the general transport master plan, seeking to improve the quality of service and the reach of the network to foster investment and leverage Romania’s favorable geographic location. The aim is to balance increasing demand and available fiscal means, ensure complementarities between different transport modes and define priorities for medium and long-term investment.

The majority stake in the state-owned railway freight company (CFR Marfa) has been sold to a strategic investor. A professional board and management were appointed in the government-owned passenger operator (CFR Calatori). Significant measures have been taken to improve the profitability of the railway system, including the closure of the most unprofitable passenger routes. Authorities acknowledge that these measures are just a start and will support efforts of the boards and management of the rail infrastructure and passenger companies to reduce costs and increase revenues.

In the energy sector, the authorities have taken a number of actions to establish a framework to improve the sector’s efficiency. Electricity and gas legislation, in line with EU energy directives, was adopted. The law on the energy regulator (ANRE) has been adopted in October 2012. Authorities have implemented the first three phases of electricity price deregulation in accordance with the agreed roadmap that envisages complete deregulation of electricity prices for non-residential consumers by January 1, 2014, and for households by December 31, 2017. Regulated electricity prices were increased by around five percent on January 1, 2013 and gas prices were increased by 5 percent for non-residential consumers on February 1, 2013.

Authorities plan to further improve the pricing and regulatory framework in the energy sector. Tariff rates for non-residential consumers were increased by 10 percent and for households by five percent in September 2012. The new transmission tariff for the gas sector was recently published and soon will be also published for consultation of the framework for the third regulatory period and the new tariffs for distribution of gas. Options about support schemes for renewable energy are under review. Steps have been taken to strengthen OPCOM as a trading platform. In line with Romania’s obligations as a member of the EU, the authorities are ready to begin negotiations on the Inter-Governmental Agreement with Russia and will also take steps to diversify gas supply. Moreover, the process of certified unbundling of transmission networks in electricity and gas in agreement with the European legislation has started.

The authorities will continue the privatization agenda and accelerate the implementation of the State Owned Enterprises (SOE) Corporate Governance Law. The Romanian government remains determined to increase private sector involvement in key SOEs. To reinvigorate the privatization effort, they have completed a SPO of 15 percent of the shares in Transgaz in April 2013, and signed the contract with the transaction advisor in May for an IPO of 15 percent of shares in Oltenia, in order to finance new investments in the company The government will also hold IPOs for Romgaz, after the audit of its reserves is completed per the recommendation of the transaction advisor, as well as for Hidroelectrica after the company exits insolvency. In addition, the government has taken measures to reduce SOE arrears over the program period. The program had indicative targets on the operating performance and arrears of about 20 monitored SOEs. SOE arrears were reduced from 4.7 percent of GDP in 2010 to a projected 2.2 percent at end-May 2013. Measures to reduce arrears included the cancellation of arrears among SOEs, debt for equity swaps, placement of SOEs into insolvency, and liquidation of SOEs. An improvement in the operating performance of central government SOEs, supported by an 11 percent cutback in employees, helped to reduce arrears. The appointment process of professional boards and management for key SOEs under majority government ownership has been initiated.

In the healthcare sector, the authorities will continue with the reform of the healthcare system. Rather than adopting a new framework law, they will prepare a new strategy plan, which sets out the main objectives of the reform and deadlines, as well as the measures to achieve the objectives. The authorities intend to publish the assessment of the impact of the reform proposals. The reform will aim to raise the efficiency of healthcare spending in Romania, enhance service quality and thereby improve health outcomes, as well as address the persistent budgetary shortfalls.

In conclusion, my authorities concur that the current precautionary Stand-By Arrangement was crucial in maintaining the reform momentum, provide additional security against unforeseen risks, and build on the considerable progress achieved over the past years. The program set the stage for strong and sustainable economic development while maintaining external and internal stability. The authorities remain committed to the economic program. They believe that a follow-up arrangement would anchor economic policies and reforms, while providing a buffer against financial and external risks.