IMF: Romania’s economic growth will turn increasingly fragile, overheating signs. Fight against corruption must continue

Although the Romanian economy is growing strongly, unemployment has fallen to a record low, and the financial sector is improving, without policy changes, the growth will turn increasingly fragile, International Monetary Fund (IMF) mission in Bucharest warns in its Concluding Statement, as a press release informs on Friday.

According to IMF officials, the economic 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.

“We project GDP growth to be about 5 percent in 2018 and to slow towards 3 percent over the medium term. Risks to this outlook are tilted to the downside. Global financial volatility, further deterioration in fiscal and external balances, or weakening of institutions could dent investor confidence in Romania. The continuation of current expansionary policies would undermine the country’s capacity to withstand a severe shock,” the release reads.

The US-based financial institution shows that a prudent mix of fiscal consolidation and monetary tightening would 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,” the concluding report shows.

Moreover, 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.

Predictability, prioritization, efficiency for strong governance

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, IMF staff team points out.

“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,” US-based institution stated.

Efforts in improving revenue collection, increasing expenditure efficiency, enhancing absorption of EU funds and enforcing the fiscal responsibility law, could have a significant impact on Romania’s GDP.

“Tax changes need to be more predictable and less frequent, and further tax rate cuts should be avoided. A comprehensive review of the tax system should be conducted, given multiple changes to the tax system in recent years. Tax collection efficiency could be improved, including by rationalizing exemptions and reforming tax administration, especially for VAT. Implementing and operationalizing new IT infrastructure in revenue administration is a key priority, given Romania’s outdated and fragile systems,” IMF shows, adding that the prioritization of large investment projects should be enforced and reflected in annual budgets.

As regards the EU funds, an improved management, especially at line ministries, is essential to ensure a high absorption rate, the financial institution said, appreciating the efforts made by the Ministry of EU funds and Ministry of Finance in this respect.

At the same time, Romania has a sound fiscal responsibility law, but, according to IMF, its fiscal rules have not been observed. Better enforcement would increase fiscal discipline and predictability, and could start by better integrating the Fiscal Council’s work into the budget process.

In terms of corporate governance, 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.

An IMF staff team visited Bucharest during March 6-16 to conduct the 2018 Article IV consultation discussions.

Read also about IMF recommendations for the domestic financial sector.