Romania: Selected Issues

Abstract

Romania: Selected Issues

The Need to Bolster Expenditure Efficiency in Romania1

Core Questions

  • What have been the main developments on public expenditure in Romania? Expenditure dropped following the strong consolidation since 2010. Total expenditure was reduced by about 6 percentage points of GDP from 2009 to 2014. Expenditure-to-GDP ratio is now lower than in peer countries, by about 10 percentage points compared to the EU average and 5 percentage points compared to the average in Central, Eastern and South Eastern Europe.

  • How can Romania address recent lowering of revenue while expenditure is already relatively low? Recently, the authorities adopted a package of large tax cuts that may require further consolidation measures from the expenditure side. Against this background, expenditure efficiency needs to be bolstered to ensure provision of public goods and services and address economic and social needs. From an economic classification, the wage bill is below peer countries and close to the authorities’ target; thus, the focus should turn to resisting pressures for a rebound and enhancing efficiency. Expenditure on goods and services is broadly in line with peer countries. Social benefits are lower than in peers. Investment spending seems to be the only area where Romania exceeds noticeably comparator countries. From a functional classification, spending in key sectors is generally lower than in comparator countries, including education, health, and social protection sectors.

  • How can expenditure efficiency be improved from the perspective of economic classification? The wage policy should ensure a strong link between pay and productivity and between wage increases and performance. Efforts should be made to ensure sufficient incentive structure in the public sector, including appropriate pay differentiation across skills and positions. On investment spending, the prioritization of large investment projects should be enforced and reflected in the annual budget formulation. This prioritization approach should be extended to medium-size investment projects, and thereafter to local government projects. Low priority and low efficiency investments, financed by national budget at the central and local levels, should be cancelled to allow allocating budgetary resources to high-efficiency projects. Moreover, bottleneck to EU Fund absorption should be addressed swiftly.

  • How can expenditure efficiency be improved from the perspective of functional classification? In the education sector, technical and vocational training could be enhanced to improve value-for-money from education spending. In the health sector, the shift from hospital-based treatments to primary care should be accelerated; the list and price of reimbursable medicines should be updated on a regular basis; and the centralized procurement system should be expanded, including to hospitals under the control of local governments. In the social protection sector, reforms should focus on ensuring progressivity by means-testing social transfers.

A. Introduction

1. Romania has undertaken a strong fiscal consolidation since 2010, which reduced expenditure to among the lowest in the region. Following a rapid expansion of expenditure and the deficit from 2005 to 2009, the Romanian authorities embarked on a consolidation path from 2010. The fiscal consolidation came almost entirely from the expenditure side as revenue-to-GDP ratio remained broadly unchanged (Figure 1).2 Total expenditure was reduced by about 6 percentage points of GDP from 2009 to 2014 (Table 1). Romania’s expenditure-to-GDP ratio is lower than in peer countries, by about 10 percentage points compared to the EU average and 5 percentage points compared to the average in Central, Eastern and South Eastern Europe (Figure 2).

Figure 1.
Figure 1.

Fiscal Adjustment

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 114; 10.5089/9781475555370.002.A002

Source: Eurostat.
Table 1.

General Government Expenditure, 2005–14

(In percent of GDP)

article image
Source: Eurostat.

The figure in the column “difference” correponds to 2008–14.

Figure 2.
Figure 2.

Total Spending: 2013 vs. 2008

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 114; 10.5089/9781475555370.002.A002

Source: Eurostat.Note: CESEE refers to Central, Eastern, and South Eastern Europe.

2. Expenditure may be subject to further reduction as the authorities recently adopted a package of large tax cuts, which is straining the near- and medium-term fiscal outlook. To date, much of the expenditure-based fiscal consolidation has relied on one-off measures and across-the-board cuts, which will be difficult to rely upon in the future. Some wage-related consolidation measures were phased out; in addition, some of those measures were ruled unconstitutional and the government has been ordered to pay compensation claims. Moreover, the recently adopted package of tax cuts adds to the fiscal pressures. Those tax cuts would widen the deficit and reverse the consolidation trend in 2016 and beyond, and may require offsetting measures from the expenditure side.

3. The following analysis aims at benchmarking expenditures in Romania against peer countries to provide indications on areas where savings can be found and/or efficiency gains can be made.3 This high-level benchmarking analysis suggests that Romania’s expenditure is relatively low at the aggregate level as well as in most economic and functional items. The analysis points to the need to primarily focus on improving efficiency and effectiveness, and in the meantime create fiscal space to address the growing fiscal pressures. Subsection B analyzes expenditure by economic classification, and subsection C examines expenditure by function focusing on the large spending sectors.

B. Economic Classification

Wages

4. Following a sharp expansion in the 2000s, public sector wage bills were drastically curtailed in the early 2010s. The wage bill expanded from 8.7 percent of GDP in mid-2000s to around 10.7 percent by the end of that decade. In 2010, the government introduced forceful measures: nominal wages were reduced by 25 percent, and employment was reduced through the one-to-seven rule (one hiring per seven departures). Consequently, the sharp increase of 2 percentage points of GDP during 2004–09 was unwound in only two years; the wage bill dropped to 7.8 percent of GDP by 2011 and 7.7 percent in 2014.

5. However, the consolidation measures were phased out or reversed. Wage increases resumed in 2013. The one-to-seven hiring policy was terminated in 2013 and replaced with a one-to-one rule. Furthermore, some wage-related consolidation measures were ruled unconstitutional and the government was ordered to pay compensation claims to be made over a number of years. As a result, wage bills rebounded in 2013, although to levels well below the previous peak.4 Furthermore, the minimum wage was raised from RON 600 to RON 1050 in 2015, and the government intends to increase it further to RON 1250 in May 2016. In addition to its direct spending pressures, this increase created distortions in the public sector wage system, as the salary of low-skilled public servants at the minimum wage level moved up to that of higher-skilled public servants whose salaries were not revised. The government intends to address these distortions through a unified wage law which would require some upward shift of the entire wage system and add to the spending pressures.

6. International experiences suggest that structural reforms of the wage system, instead of ad hoc measures, are required to lock in fiscal savings (IMF, Fiscal Monitor, April 2014). Public wage bill reforms should aim at strengthening the link between pay and productivity, improve hiring processes, and ultimately enhance efficiency in the provision of public services. Eliminating “ghost workers” and reducing absenteeism can be the first step toward boosting efficiency. An important challenge for many countries, including Romania, is to attract and retain the necessary staff to ensure efficient provision of public services. Strengthening the link between wage increases and employee performance and periodically reassessing employment levels in line with the functions of the government help ensure retention of skills and improve efficiency. Efforts should be made to ensure sufficient incentive structure in the public sector, including appropriate pay differentiation across skills and positions. Such an incentive structure could be reflected in a review of the wage grid. International experiences have shown that long-term fiscal savings from non-structural measures (such as wage and employment freezes) were about 0.7 percent of GDP smaller than savings from structural measures (such as decompressing the pay scale, restructuring the public sector based on functional reviews) (Figure 3).

Figure 3.
Figure 3.

Cumulative Change in Wage Bill 10 Years After First Year of Measures

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 114; 10.5089/9781475555370.002.A002

Source: IMF, Fiscal Monitor, April 2014.

Goods and Services

7. Goods and services also contributed to the fiscal consolidation. Consumption expenditure was reduced from its peak of 9.1 percent of GDP in 2009 to about 7.6 percent in 2014. For instance, local governments curtailed expenditure for goods and services as their balanced budget rules were strictly enforced and arrears had to be reduced. The ratio is about 0.5 percentage points of GDP below the EU average. A systematic use of a centralized public procurement system may help improve efficiency.

Interest

8. The expanding fiscal deficit and the ensuing debt accumulation in the late 2000s and early 2010s led to an increase in debt service. The budget deficit deteriorated rapidly from 1.3 percent of GDP in 2006 to 7.1 percent of GDP in 2009 (in cash terms). As a result, debt more than doubled between 2006 and 2010, from 12. 5 percent of GDP to 30.5 percent. This debt accumulation translated into larger interest bills, which expanded by about 1 percent of GDP between 2008 and 2013 and crowded out other expenditures (Figure 4). It would be advisable to ensure a downward trending debt profile to prevent soaring debt service payments.

Figure 4.
Figure 4.

Interest Payments, 2006–14

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 114; 10.5089/9781475555370.002.A002

Sources: Romanian authorities.

Capital Expenditure

9. Although investment expenditure also contributed significantly to the fiscal consolidation, Romania’s investment-to-GDP ratio is still higher than in other countries in the region. Public capital spending was reduced by 2.5 percentage points of GDP between 2008 and 2014. However, public capital spending in Romania is still about 1 percentage point of GDP higher than the average in Central, Eastern, and Southeastern Europe (CESEE) countries and 1.5 percentage points of GDP higher than the average in EU countries (Figure 5).5 Capital expenditure is the only spending item for which Romania exceeds peer countries. However, the share of projects financed with EU funds in total investment which relieves the national budget is relatively small. In 2014, EU-funded investments were only 2.2 percent of GDP (compared to 3.2 percent in Poland and 3.4 percent in Hungary), whereas domestically financed (i.e., non-EU funds) investments amounted to 3 percent of GDP (compared to 1.2 percent and 0.7 percent respectively in the two countries).

Figure 5.
Figure 5.

Expenditure by Economic Classification, 2013

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 114; 10.5089/9781475555370.002.A002

Source: Eurostat.

10. The efficiency of public investment is noticeably low. Protecting investment expenditure during the consolidation period can be interpreted as a policy to preserve growth-enhancing expenditures. However, this policy does not seem to have translated into an effective accumulation of public physical capital. Although Romania had the largest average capital spending in the EU during 2003–13, its infrastructure quality is the lowest (Figure 6).6 Similarly, despite showing the largest investments in CESEE for the last five years, road quality is the lowest. These findings suggest that there is room to enhance efficiency of investments, at both central and local levels. To this end, forceful measures to improve public investment management are necessary, particularly in transport and local development—the largest investment spending areas.

Figure 6.
Figure 6.

Capital Spending

Citation: IMF Staff Country Reports 2016, 114; 10.5089/9781475555370.002.A002

Sources: Eurostal: and World Competitiveness Report.

11. Public investment efficiency can be improved through more rigorous investment planning and control. The prioritization of large investment projects carried out by the Public Investment Prioritization Unit (PIEU) should be enforced and reflected in the annual budget formulation. This prioritization approach should be extended to medium-size investment projects, and thereafter to local government projects. Low priority and low efficiency investments, financed by national budget at the central and local levels, should be identified and cancelled to allow allocating budgetary resources to priority and high-efficiency projects. The investment planning should include satisfactory risk assessments. The newly developed commitment control system should be rolled out swiftly to all government levels and entities to identify bottlenecks in investment budget execution and allow reallocation of resources if needed to improve efficiency. Additionally, a report on project performance should be produced on a quarterly basis by the Ministry of Finance or line ministries, presented to the public investment Inter-Ministerial Committee, as well as made available to the public.

12. Furthermore, the provision of public investment could be enhanced through accelerated absorption of EU Funds. Romania has taken significant measures to improve absorption, including the creation of a Ministry of EU Funds, the centralization of some managing authorities, the reallocation of additional resources to co-financing, the approval by the EC of a structural clause to free fiscal space for Romania’s co-financing share; and a significant number of procedural measures. Despite marked improvements following those measures, Romania’s absorption remains relatively low at about 66 percent at the end of March 2016 for the 2007–13 programming period. Some further measures could be taken. Due diligence of Ministry of EU Funds and managing authorities should be strengthened to prevent corrections and delays. Line ministries should request a non-eligibility check from the Ministry of EU Funds for all projects approved for budget financing to ensure that only those projects which are not eligible under EU funding are financed from the national budget. The authorities are currently developing a model of a single account for EU-funded projects. The model aims at allowing reallocation of resources away from areas where execution and implementation rates are low to finance other projects and avoid losing resources. The model could be discussed with the European Commission and should ensure compliance with best practices in public financial management.7

C. Functional Classification

Education

13. Education spending was reduced during the consolidation period and is lower than in peer countries. Education spending dropped by 1.3 percentage points of GDP between 2009 and 2014, primarily due to the horizontal wage cut and employment restriction measures and is amongst the lowest in European countries. Spending per student is lower than in comparator countries and the Program for International Student Assessment (PISA) score is weaker (Figure 7). Moreover, Romania also shows weak performance across the components of this indicator.

Figure 7.
Figure 7.

Education Spending and Outcome

Citation: IMF Staff Country Reports 2016, 114; 10.5089/9781475555370.002.A002

Source: OCED Programme for International Student Assessment.

14. The education system appears to be skewed towards general education at the expense of technical programs. The share of graduates from tertiary programs in the field of social sciences, business and law (in total tertiary graduates) is strikingly higher (by 20 percentage points) than the EU average (Figure 8). As a result, specialists trained in more technical subjects and fields are fewer. Technical and vocational training could be enhanced to improve value-for-money from education spending. Moreover, student-teacher ratio in tertiary education—all fields considered—is more than double of the EU average.

Figure 8.
Figure 8.

Education Inputs

Citation: IMF Staff Country Reports 2016, 114; 10.5089/9781475555370.002.A002

Source: UNESCO.

Health

15. While health spending remained broadly unchanged as a share of GDP during the consolidation period, it is among the lowest in the region. Moreover, international benchmarking analysis suggests that spending efficiency is also relatively low (Figure 9). High-level indicators such as health-adjusted life expectancy, infant deaths per number of births, and diseases of the circulatory system lead to broadly a similar conclusion. International benchmarking indicates under-provision of primary health care. This might be the source of the low efficiency as patients might not have sufficient access to preventive care (with lower costs) and might be treated only when the disease has developed (with higher costs).

Figure 9.
Figure 9.

Health Spending

Citation: IMF Staff Country Reports 2016, 114; 10.5089/9781475555370.002.A002

16. The authorities are implementing various reforms to improve efficiency and create scope for the reallocation of funds within the sector. Recently, a basic health package was introduced and a health strategy was designed, which aim primarily at shifting health services away from hospital-based inpatient treatment to outpatient and ambulatory cares. A once-every-three-year health check was added to the minimum package for the uninsured population to enhance preventive services. The list of reimbursable medicines is being revised to replace those that are less cost effective. A centralized procurement system is being gradually expanded to reduce costs of medicines and equipment purchases. Those reforms should be continued. In particular, the shift to primary care should lead to effective reduction of costly hospital beds; the list and price of reimbursable medicines should be updated on a regular basis; and the centralized procurement system should be expanded to hospitals under the control of local governments.

Social Protection

17. Social protection spending was also curtailed substantially during 2009–13. The level of spending in this area is relatively low compared to comparator countries. Furthermore, the social protection system seems to play a less redistributive role than in peer countries, which does not help address the large inequality.8 Reforms of the social protection system should focus on ensuring progressivity by means-testing social transfers.

18. The demographic structure will intensify pressures on pension-related spending. Pension-related payments are projected to expand by 0.7 percentage points of GDP by 2030 and by 2.9 percentage points of GDP by 2050 (Table 2). Moreover, despite a comprehensive reform of the pension system in the early 2010s, various special pension systems have reemerged in recent months putting at risk the success of the reforms and the sustainability of the pension system, while creating fiscal pressures. To ensure long-term financial sustainability, the private pension system should be developed and the planned transfer of contribution to the Pillar II should be respected. Special pension systems should be avoided to prevent fragmentation; acquired rights can be restored but new comers should not be granted preferential treatments.

Table 2.

Pension

article image
Source: IMF staff estimates.

References

  • Fiscal Monitor, 2014, “Public Expenditure Reforms, Making Difficult Choices,” International Monetary Fund, Washington D.C. http://www.imf.org/external/pubs/ft/fm/2014/01/fmindex.htm

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  • Hallaert, J.J., and M. Queyranne, 2016, “From Containment to Rationalization: Increasing Public Expenditure Efficiency in France,” Working Paper No. 16/7 (Washington: International Monetary Fund).

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  • International Monetary Fund (IMF), 2015a, “From Expenditure Consolidation to Expenditure Efficiency: Addressing Public Expenditure Pressures in Lithuania,” by D. Coady and N. Geng, Country Report No. 15/139; http://www.imf.org/external/pubs/ft/scr/2015/cr15139.pdf

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  • International Monetary Fund (IMF), 2015b, “Social Spending Reform and Fiscal Savings in Slovenia,” by C. Feher, I. Halikias, and J. Tapsoba, Country Report No. 15/42, http://www.imf.org/external/pubs/ft/scr/2015/cr1542.pdf

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  • International Monetary Fund (IMF), 2015c, “Making Public Investment More Efficient,” Policy Paper, Washington D.C. http://www.imf.org/external/np/pp/eng/2015/061115.pdf

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1

Prepared by Ivohasina F. Razafimahefa.

2

Despite significant revenue measures (such as a VAT rate increase and introduction of new taxes), the revenue-to-GDP ratio remained broadly unchanged, possibly due in part to a large output gap during the consolidation period.

3

The approach in this analysis follows a framework developed recently by the Fiscal Affairs Department of the IMF and already applied to some countries, including Lithuania (IMF, 2015a), Slovenia (IMF, 2015b), and France (IMF, 2016).

4

Nevertheless, the number of public employees is still below pre-crisis levels; and the real wage growth, other than from the minimum wage increases, was low and limited to a few groups.

5

The benchmarking of capital spending includes capital transfers.

6

IMF Board Paper on Making Public Investment More Efficient, 2015c. The infrastructure and road quality indices are derived from a combination of published quantitative data (such as number of phone lines per 100 population) and results of executive opinion survey.

7

The following principles should be observed: (i) expenditures need to be on budget; (ii) the account needs to operate in the new commitment control system; (iii) commitments need to be registered at the stage the public procurement is launched to avoid over-commitment; (iv) comprehensive reporting in the cash budget, financial statement of performance, and the balance sheet has to be ensured; (v) monitoring mechanisms, at least on a monthly basis, are required to ensure that commitments are in line with the budget; and (vi) an assessment of compliance with national and EU legislation should be conducted.

8

The redistributive role is measured as the difference between the Gini coefficient based on market income and the Gini coefficient based on disposable income (or income after taxes and transfers).

Romania: Selected Issues
Author: International Monetary Fund. European Dept.