The IMF mission, led by Jan Kees Martijn, IMF mission chief for Romania, visited Bucharest between May 30 and June 10 to conduct discussions on the 2022 Article IV Consultation with Romania.
The IMF mission said in a statement that after a solid recovery from the pandemic, Romania is now facing adverse spillovers from the war in Ukraine and rising inflation. Moreover, the country is confronting these new challenges from a weak fiscal position. Measures to alleviate the impact of surging prices, in particular for energy, should be temporary and targeted at the most vulnerable, to limit their budgetary cost and not hinder energy conservation. To rebuild fiscal space and support market borrowing for budget financing, policies to reduce the fiscal deficit over the medium term need to be introduced without delay. This should include ambitious tax reform to ensure that everyone pays their fair share. Also, every effort needs to be made to use the substantial available NGEU funds efficiently. Monetary policy should firmly aim at returning inflation and inflation expectations to Romania’s central bank target band, while financial sector policies need to preserve the strength of the banking system.
Direct risks from the war in Ukraine are limited as Romania is a substantial grain producer, largely self-sufficient in energy with only limited imports from Russia, and other direct trade and financial links with Russia and Ukraine are negligible. However, a broad Russian gas shut-off would raise energy prices further and reduce activity in European trade partners. Other risks could also worsen the outlook: high inflation could reduce demand further and trigger a wage-price spiral; external and domestic financing conditions may tighten more than anticipated; and domestically, stalling reforms could weaken confidence and risk a credit rating downgrade. On the upside, rapid implementation of reforms envisaged under Romania’s National Recovery and Resilience Plan (NRRP) could lift growth above the baseline, the statement reads.
Through March 2023, Romanian authorities are implementing targeted payments to vulnerable households but also a price cap for most users at levels prevailing before the surge in energy prices in the fall of 2021. The cost to the budget is expected to be broadly offset by windfall profit taxes on energy producers, and higher dividend payouts of state-owned enterprises (SOEs). The authorities need to ensure that the system of compensating suppliers is working well to avoid cash-flow bottlenecks. Also, it would be helpful to start raising the price caps before March 2023, to avoid a sudden price shock and promote energy efficiency. At the same time, in the event of further shocks, any renewed fiscal support needs to be well-targeted at poor households.
The IMF mission also said that strong fiscal measures will be needed in Romania to rebuild fiscal space and lean against deteriorating financing conditions. While welcoming the authorities’ intention to reduce the fiscal deficit in 2022 to 5.8% of GDP, the mission projects it at 6¾ percent based on current policies. With administrative reforms to improve tax collection and the lapse of the temporary support measures, the deficit is forecast to moderate over the medium term, but debt would continue to rise. Efforts to modernize revenue administration need to continue, including through digitalization and improved taxpayer services, in line with commitments under Romania’s NRRP. However, this will not be sufficient to restore fiscal sustainability.
According to the mission, to reduce the deficit to a sustainable level below 3% of GDP and stabilize debt, on the revenue side, tax policy measures amounting to at least 2% of GDP should be implemented.
Pension system reforms committed in the NRRP should be expeditiously implemented. Public sector wages should also be set in a predictable way, and their influence on private wages and overall competitiveness taken into account. Also, medium-term budgeting needs to be strengthened.
The monetary tightening undertaken by Romania’s central bank has helped anchor inflation expectations. Policy rate increases and tight liquidity management have been combined to keep monetary conditions broadly aligned with global and regional trends. The functioning of the government bond market has also been preserved. Nonetheless, the pass through of energy and food prices to core inflation continues to rise.
Exchange rate flexibility should be gradually increased. A broadly stable exchange rate against the euro has avoided fueling inflation and underpinned confidence in the domestic currency. However, as external competitiveness has weakened and to help absorb external shocks, exchange rate flexibility should be increased over time, together with the necessary fiscal consolidation.
Financial sector policies need to balance preserving the Romanian banking system’s soundness and maintaining the flow of credit. Emerging from the pandemic, the banking system has maintained its strong capital, liquidity, and profitability position. The NPL ratio has fallen below pre-pandemic levels, and loan-loss provisioning remains much higher than the EU average. Financial intermediation has improved, with strong credit growth over the past two years. In this context, credit guarantee schemes should be reduced over time. Furthermore, raising the countercyclical capital buffer was appropriately calibrated. While providing a safety net in the current uncertain environment, the application of the new loan moratorium needs to be limited to affected borrowers, as per the statement.
The IMF also pointed out that the additional funds available under the NGEU program represent an important opportunity, but also a significant challenge to absorb. Already, Romania lags peers in absorbing EU funds. The authorities are advised to expeditiously implement recent IMF recommendations for public investment management, including to strengthen medium-term planning, and develop a centralized coordination mechanism and a pipeline of appraised investment projects across sectors.
Better public investment management would also help implement the climate policies committed under the NRRP. Romania consumes less energy per capita than most EU countries. Nonetheless, the investments required to meet NRRP climate targets are large, and projects need to be executed without delay. Investments to strengthen energy security (such as the new gas interconnector with Bulgaria and the development of new gas fields in the Black Sea) should also receive high priority, the IMF also said in its statement.
Structural reforms and investments to raise productivity would boost Romania’s growth potential. This requires expanding digitalization, strengthening the anti-corruption framework, improving the health and education systems, and reforming state-owned enterprises. Also, addressing large income gaps between regions requires particular attention to strengthening regional and local capacity and infrastructure, the IMF concluded.