General remarks

Over the last decade, Romania improved markedly its macroeconomic fundamentals, with the support of the International Monetary Fund, the European Union and the World Bank. After re-entering the positive GDP growth territory in 2011, the economy grew by 2.9 percent in 2014 and CPI inflation dropped from 6.3 percent at end-2008 to 0.41 percent in January 2015. Following a strong external adjustment, the current account deficit dropped from double-digit levels before the crisis to 0.5 percent of GDP in 2014. The fiscal consolidation process led to a reduction in the public deficit from a peak of 9 percent in 2009 to 1.9 percent of GDP in 2014. Romania’s banking system is strong, NPL ratios decreased, adequate buffers were kept in place and no public funds have been necessary to support the banking sector during the global financial crisis. The international reserves coverage in Romania is adequate. The reserve level of EUR 34.3 billion at end-January 2015 was above the standard rules of three months coverage of prospective imports and is also in line with the new reserve adequacy metric for emerging markets. The recent rebound in economic activity helped labor market conditions to improve and the unemployment rate declined to 6.8 percent in 2014.

Despite all these achievements, the economy remains vulnerable to adverse developments in international markets, regional unrest, and continued bank deleveraging. So it is clear that the authorities will have to remain vigilant, act proactively, and take the necessary steps to contain these risks. Therefore, the Romanian authorities expressed their dedication to continue with firm policy implementation and consider maintaining strong fiscal, external, and financial sector buffers to safeguard against risks essential.

Macroeconomic performance

Although the environment was challenging, Romania’s economic recovery continues. Romania significantly reduced its internal and external imbalances through an important fiscal consolidation and prudent monetary and financial sector policies. Staff rightly notes that growth is becoming more broad-based and sustained amid improved confidence. GDP is projected to remain strong in 2015 at 2.7 percent. The main engine of growth was exports, accompanied by a successful harvest and a robust industrial output.

The inflation rate evolved quickly during the last two years. In the second half of 2013, the central bank brought the inflation back in its target range. At the end of 2014, the annual CPI inflation rate went below the ±1 percentage point variation band of the 2.5 percent flat target, with a value of 0.83 percent. The slowdown in the overall CPI inflation rate was driven by developments in the CPI components affected mainly by supply-side factors. Specifically, the prevailing impact came from the unanticipated shocks on volatile fuel and agricultural prices. The latter fell against the background of a new bumper crop across the region and amid domestic supply supplemented by higher imports from the European states that were hit by the import ban to Russia as of August 2014. Inflation is projected to remain low in 2015, reaching an annual average of about 1 percent.

The external position has been consolidated. The current account deficit narrowed to a historic minimum of 0.5 percent of GDP in 2014. Romania continued and improved its presence on international capital markets, thus generating significant buffers. In May 2014, Standard & Poor’s upgraded Romania to the investor grade level and the country continued to successfully tap into international capital markets. Sovereign and CDS spreads considerably narrowed during recent years reaching significant low levels. The central bank sustained international reserves at €34 billion as of end-January, while making substantial repayments to the Fund.

Fiscal policy

Significant progress has been made with regard to fiscal policy. Since the start of the first program, Romania considerably improved its fiscal position and reduced fiscal imbalances, proving a sound fiscal policy. In 2014, the fiscal deficit went below 2 percent of GDP, from almost 9 percent in 2008. For 2015, the budget framework stays anchored in the Medium-term Budgetary Objective of 1 percent of GDP (plus an adjustor of ¼ percent of GDP). In an attempt to stimulate the economic growth and incentivize shifts from the informal to the formal sector, the Romanian authorities are contemplating potential measures to restore the fiscal environment to its pre-crisis level. For that reason, they are considering a new Fiscal Code designed to reduce tax rates from 2016 and beyond, although they are aware that improved revenue collection must be an important part of this growth enhancing package. The Romanian authorities are determined to safeguard the fiscal consolidation achievements and to maintain the commitment under the Stability and Growth Pact.

Monetary and financial policies

The monetary authorities continued to appropriately respond to economic developments. The National Bank of Romania (NBR) pursued the rate cutting cycle, lowering the policy rate to 2.25 percent in February 2015. These measures were accompanied by a narrowing of the interest rate corridor and lowering of the rate of minimum reserve requirement. The central bank will ensure adequate liquidity conditions in the banking system, while underpinning the good functioning of money markets. The Romanian monetary authorities consider that a consistent implementation of an adequate macroeconomic policy mix and stepping-up structural reforms, along the lines of the external financing arrangements, together with sustainable financial intermediation and an appropriate remuneration of bank deposits are pivotal to consolidating the Romanian economy and enhancing its resilience to external shocks.

The Romanian financial sector is stable. It maintains reassuring capital buffers, enhanced liquidity and provisioning, but is still confronted with pressures from lowered but continuing foreign bank deleveraging. As noted by staff, a comprehensive NBR action plan consisting of NPLs sales, write-offs and higher provisioning helped NPLs to decline in 2014 by about 8 percentage points to 13.9 percent, with an IFRS provisioning ratio increased to 68.9 percent. The capitalization of the banking sector increased above 17 percent. The real annual growth rate of domestic currency loans gained momentum, thanks to the pass-through of the successive policy rate cuts onto lending rates on new business to companies and households, as well as the easing of money market liquidity conditions. The NBR will continue to closely monitor and supervise the banking system and take any necessary measures to ensure that banks maintain sufficient capital and liquidity. Moreover, in close coordination with the IMF and the EC, the NBR will continue to regularly conduct top-down and bottom-up solvency stress tests as well as liquidity stress tests of the banking industry.

The authorities will focus on further strengthening the non-bank financial sector supervision and providing it with resolution powers for insurance companies. They are drafting a new personal insolvency law, taking into account cross-country experiences. They are committed to adopt this law only after a thorough impact assessment and broad stakeholder consultations.

Structural reforms

The implementation of the structural reform agenda is progressing, although it experienced some setbacks. Central government-owned SOE arrears have been reduced by 1.5 percent of GDP over the past two years and local government-owned SOE arrears are still at around 1 percent of GDP at end-2014, while the SOE sector became profitable following several years of aggregate losses. In the last years, the authorities have launched a landmark IPO of the state-owned natural gas producer (Romgaz), sold 10 percent of the shares in the nuclear energy company (Nuclearelectrica) and the energy regulator made significant steps towards the liberalization calendars. Moreover, Romania has taken important steps to participate more fully in the European energy market. The authorities removed physical and legal obstacles to gas exports and linked Romania’s electricity grid to those of four neighbors. They deregulated the gas and electricity markets for non-residential consumers, which is a major achievement as it accounts for the bulk of energy consumption. The transport sector is lagging behind, especially with regards SOE corporate governance. After a failed privatization, measures have been taken to restructure the rail freight operator CFR Marfa by downsizing its staff by more than one fourth. However, Marfa’s privatization process has stalled and a further restructuring is needed.

The Romanian authorities have reiterated their commitment to pursue the necessary measures to advance the structural reform agenda. They recognize the importance of structural reforms, especially in the energy and transportation sectors. Therefore, international partners have been informed about measures to further improve performance of SOEs, to prepare restructuring plans where necessary and align decisions with the national strategies. The authorities are committed to further develop the SOE governance principles, and are currently working together with the World Bank to improve the legislative framework. Furthermore, they will specifically focus on job creation, by removing barriers to employment and taking measures to reduce skill mismatches, especially for the young. To better respond to the need for prioritization and better allocation of resources to national priorities in the transport sector, including a rail network rationalization, the Romanian authorities have prepared a Transport Master Plan, which has been sent to the European Commission for consultation.