KEY ISSUES Background: Romania has in large part reduced internal and external imbalances through sound macroeconomic policies. However, income convergence with the EU has been slow and weak public infrastructure has emerged as a bottleneck for faster growth. At the same time, Romania remains vulnerable to external shocks and the repair of balance sheets is not yet complete. Policy recommendations: Going forward, sustainable macroeconomic policies need to be combined with measures that boost the efficiency of public spending, reinvigorate delayed state-owned enterprise (SOE) reforms, and resolve crisis legacies in the financial sector. • Fiscal policy. Maintain the fiscal adjustment achievements, put public debt on a firm downward path, ensure provision of higher quality public infrastructure, and improve revenue administration and public expenditure management including through higher absorption of EU funds. • Monetary policy. Keep the easing bias as inflation has fallen below the target band and support a private credit rebound. Improve the policy framework by gradually moving to full-fledged inflation targeting. • Financial sector. Maintain the intense watch on the banking system focused on asset quality and non-performing loans reduction, further strengthen non-bank supervision, develop capital markets, and create effective insolvency frameworks. • Structural reforms. Improve financial performance and generate resources for investment of SOEs by implementing good governance principles, restructuring and increased private ownership; further deregulate energy markets. Outlook and risks: Staff expects sustained growth supported by strong domestic demand. Better EU funds absorption could boost the growth potential by about ½ percent annually. However, increased volatility in the external environment and failure to implement a much needed infrastructure upgrade present downside risks.
1. This statement provides information that has become available since the issuance of the Staff Report on March 11, 2015. This information does not alter the thrust of the staff appraisal.
2. The cash budget recorded a surplus of 0.3 percent of GDP for the first two months of 2015 compared to a deficit of 0.5 percent of GDP during the same period of 2014. Based on preliminary data, the surplus reflects strong spending restraint coupled with solid revenue growth. In the first two months, spending was lower by 0.6 percentage points of GDP relative to last year, with lower subsidies and spending on goods, services, and capital accounting for most of the drop. At the same time, total revenues were higher by 0.2 percentage points of GDP, driven mostly by higher VAT and non-tax revenue receipts and reflecting base effects as well as stronger domestic demand.
3. The authorities are considering the reduction of tax rates, but their plans are still evolving, including how to offset the revenue loss. Based on the latest data available, staff estimates that the net loss in budget revenues in 2016 from the proposed tax changes could reach 2.2 percent of GDP. This takes into account the projected impact on revenues from stronger economic activity (0.7–1.0 percent higher nominal GDP in 2016). The revenue shortfall would widen further from 2017 with proposed additional tax rate reductions. At this stage, staff does not have information about potential measures that the authorities may take to offset the proposed tax changes.
4. In February, inflation remained low. Headline annual inflation was at 0.4 percent, unchanged from the previous month. Core inflation declined to 1 percent.