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IMF releases 2017 Article IV Consultation on Romania, points to risks related to tax easing and political tensions

IMF releases 2017 Article IV Consultation on Romania, points to risks related to tax easing and political tensions
The International Monetary Fund (IMF) has released conclusions after the consultations with Romania on Article IV in 2017 and has issued the report and the Statement by the Executive Director for our country.

The report reads that the Romanian economy will register a 4.2% growth in 2017, whereas the main risk in terms of prospects is related to tax easing, which could negatively affect the markets confidence.

The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultations with Romania on May 22, 2017.

The report reads that “Romania strengthened its economy considerably after the global financial crisis. Growth has been solid and unemployment low. Public debt and fiscal and current account imbalances are moderate compared to many emerging markets. Notwithstanding this progress, significant challenges remain and the momentum of progress in policies has waned. Income convergence with the EU has slowed and poverty is among the highest in the EU. Successive tax cuts and wage increases in excess of productivity gains have supported consumption, but investment remains weak. A reorientation of policies to prioritize investment will more sustainably achieve the authorities’ objective of bringing more Romanians into the middle class.

Romania saw strong economic growth in 2016, resulting in a closed output gap. Private consumption was boosted by an expansionary and pro-cyclical fiscal policy and wage increases. The cyclically adjusted budget deficit grew by 1½ percent of GDP in 2016, reflecting large tax rate cuts and wage increases. Headline inflation remained subdued due to indirect tax cuts, administrative price adjustments, and low euro area inflation and oil prices. There has been welcome progress in reducing banking sector non-performing loans.

Growth is expected to reach 4.2 percent in 2017 – supported by continued stimulus to private consumption from a new round of fiscal relaxation and wage increases – and to moderate to 3½ percent in the medium term. A reorientation of policies – from stimulating consumption to supporting investment – is required to reduce poverty, raise medium term growth, and accelerate the pace of convergence towards the EU’s income level.

The main risks to the economic outlook include a perception of weakening fiscal prudence or institutions, which could adversely affect market confidence. This, together with heightened political tensions, could erode consumption and investment, increase the cost of government borrowing and put pressure on the exchange rate which would affect banks’ balance sheets through their FX exposures. Maintaining adequate reserve levels, a flexible exchange rate, and fiscal buffers will help against such risks. Prudent economic policies and visible steps to accelerate the pace of structural reforms and improve governance would send a powerful signal about Romania as a good place for doing business.

The Executive Board also discussed an ex post evaluation of the precautionary SBA with Romania approved in September 2013. The ex post evaluation finds that while policy objectives under the program were broadly appropriate, and some progress was achieved, setbacks on key structural reforms and concerns about the quality of fiscal measures prevented program completion. The report also includes recommendations for the design of future Fund programs.”

Risks

Growth is projected to remain above potential in 2017 and slow to around 3¼ percent in the medium-term. On current policies, real GDP growth could reach 4.2 percent this year.

However, the outturn will depend, inter alia, on whether the authorities take measures to bring the deficit under the EU’s excessive deficit procedure (EDP) threshold of 3 percent of GDP. Growth is expected to decline in the medium term as the transitory effects of the fiscal impulse wear out and progress on structural reforms remains slow. Growth could rise to about 4½ percent over the medium-term if macro-critical reforms to boost EU funds absorption are implemented.

Risks to the medium-term baseline are tilted to the downside. A perception that fiscal prudence has been abandoned—for example, due to fiscal measures currently under consideration—or institutions are weakening could adversely affect market confidence. Such concerns have recently led Moody’s to downgrade Romania’s outlook to stable from positive. There are also risks to competitiveness if large public sector wage increases lead to similar wage increases in the private sector. Such developments, together with potential heightened political tensions, could erode consumption and investment, increase the cost of government borrowing and put pressure on the exchange rate which would affect banks’ balance sheets through their FX exposures. While adequate reserve levels, a flexible exchange rate, and fiscal buffers will help against such risks, it is important that policies remain prudent, particularly during a period when external conditions are unsettled, and uncertainty about policy and financial market developments remains elevated.

The government forecast assumes a higher impact of the fiscal and structural measures introduced in their program on near- and medium-term growth prospects. It projects growth at 5.2 percent for 2017 and above 5.5 percent during 2018–2020. The central bank’s growth forecast is broadly in line with staff’s, the IMF report reads.

It adds that “without additional effort, the budget deficit is set to exceed the target of 3 percent of GDP in 2017. Staff projects a deficit of 3.7 percent of GDP on account of new wage and pension increases and tax cuts in the 2017 budget that will add to the effects of the previously legislated tax cuts entering into effect this year. Staff advised near-term measures to reduce the deficit focusing on expenditure reprioritization3 and the postponement of a planned pension increase, while safeguarding social spending. The authorities prefer to wait to monitor budget execution in the first part of the year. However, without timely action, reducing the deficit to 3 percent may require withholding the automatic 10 percent spending buffer and delaying capital spending, both of which are less desirable ways to achieve the target.”/IBNA

Source: romaniajournal.ro

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