The Romanian economy is growing strongly, unemployment has fallen to a record low, and the financial sector is improving shows the report issued by the International Monetary Fund ( IMF). An IMF staff team visited Bucharest during March 6-16 to conduct the 2018 Article IV consultation discussions.
The report also shows that without policy changes, growth will turn increasingly fragile. “For one, inflation could increase further, with possible social implications. A combination of fiscal moderation and monetary tightening would be the best course of action. Monetary tightening alone would have to push interest rates to a level that weighs on investment and competitiveness. Continuing sizable fiscal deficits, especially with low investment spending, would also reduce the space to support the economy in future downturns and weaken Romania’s growth potential. Sustaining an inclusive convergence toward advanced European Union (EU) countries’ living standards calls for a predictable policy framework with medium-term orientation, supported by an efficient government and strong governance. The best time to act on all these fronts is now, with monetary and fiscal policies acting in unison” says the IMF.
Economic growth surged to 7 percent in 2017—the highest in the EU but the strong growth has been fuelled by domestic consumption, on the back of a multi-year fiscal expansion and minimum wage hikes. An accommodative monetary policy stance and improving EU economy also helped. The current account deficit widened, as expanding imports offset the improving demand for Romania’s exports. A tight labor market is seeing private sector wages growing at double-digit rates. The target of the National Bank of Romania (NBR) was met in 2017, but inflation rose to 4.7 percent in February.
Growth is expected to decelerate from last year’s high level due to multiple factors: a waning fiscal impulse, low public investment, slow progress on structural reforms, and tightening financial conditions concludes the report and wards that the continuation of current expansionary policies would undermine the country’s capacity to withstand a severe shock.
Fiscal moderation coupled with monetary tightening to enhance macroeconomic stability would be beneficial, and avert overheating, while reducing the fiscal and external deficits, and enhancing macro-financial stability.
Monetary policy needs further tightening to rein in inflation and anchor expectations, given the pressure from global energy prices, strong domestic demand, a tight labor market, and recent currency dynamics. The recent monetary tightening was a welcome start, and we encourage the NBR to continue raising the policy rate, while also managing liquidity to align the market and policy rates. A more conservative fiscal stance would reduce the burden on monetary policy and help improve the balance between consumption and investment. If this task is left to monetary policy alone, interest rates would have to be raised to such a level that will increasingly weigh on investment and competitiveness.
A smaller fiscal deficit is warranted, given the strong cyclical upswing. Large deficits during economic booms tend to cause domestic and external imbalances, result in excessive debt accumulation, and force a stronger (and pro-cyclical) adjustment during a downturn. The deficit should be reduced below a cyclically neutral level in the short run and further to 1.5 percent of GDP by 2020, contributing to a smooth return to Romania’s medium-term budgetary objective (MTO) under its EU commitments. Relative to current policies, we estimate that measures amounting to 0.6 percent of GDP—which should be of high quality—are needed to meet the government’s 3 percent of GDP deficit target for 2018, even as a smaller deficit target would be desirable. These measures should avoid a further deterioration of the budget structure and protect capital spending.
The IMF stressed few key principles for strong governance: predictability, prioritization, efficiency
Efficient delivery of government services is indispensable for sustaining inclusive convergence towards EU living standards. Predictable and medium-term oriented policies facilitate structural reforms, investment and growth. These go hand in hand with a more rules-based governance, continuing the fight against corruption, and a more resilient financial sector.
Romania’s comparatively low (and declining) tax revenue as a share of GDP underscores the importance of effective revenue mobilization and expenditure management. These would help with large unmet needs in priority areas including infrastructure, education, and health, as well as long-term challenges linked to adverse demographic dynamics. Efforts in the following areas could have a significant impact:
Structural reforms should be re-energized to alleviate constraints on growth. Improving service and financial performance of many state-owned enterprises (SOEs) requires a renewed commitment to strong corporate governance. In this context, Law 111 should be preserved, and any weakening of the existing corporate governance legislation should be avoided, while restructuring and privatization of SOEs should resume. The government plans to establish a sovereign investment fund and a development bank should reflect international experience on the risks associated with such entities, and their design would need to be based on best practices, including on governance, reporting, and management of fiscal risks.
Romania’s progress on the fight against corruption has been recognized internationally, and needs to continue. Reducing corruption would help improve government revenue, enhance spending efficiency, and strengthen competitiveness. Judicial independence and the rule of law should be upheld as the cornerstones of the fight against corruption and a rules-based governance.
Financial sector: stay the course and strengthen resilience
Banks are well capitalized and liquid, profitability is increasing, and non-performing loans (NPLs) have declined to 6.4 percent of total loans in December 2017, close to the EU average. Potential new risks to financial stability arise from the high exposure of banks to the Romanian sovereign and to the real estate sector, banks’ funding in foreign exchange (FX), and the fast growth of non-bank financial lenders. In line with the ongoing Financial Sector Assessment Program (FSAP), the following recommendations would further strengthen the financial system:
Legislative initiatives that harm the financial system should be avoided. Several recent initiatives would, if enacted, reduce the amount of credit provided to the real economy and slow the resolution of NPLs, thereby adversely affecting financial stability. These include the proposals for capping interest rates for household lending and the prices at which individuals re-purchase debts acquired by third parties.