WB: Fiscal uncertainty and migration, among Romania’s main risks and challenges

Economic growth across Europe and Central Asia is slowing, with regional growth estimated at 1.8% for 2019, according to the latest World Bank Economic Update for Europe and Central Asia (ECA), “Migration and Brain Drain” report. This estimate, the lowest in four years, reflects slowing growth in both the Russian Federation and Turkey, the region’s two largest economies. The report also notes robust growth in other parts of the region, including countries in Romania and other Central European states, Central Asia and the South Caucasus.

Slower growth in the region parallels a global downward trend and underlines the need to boost productivity growth and increase investment – which has been declining over the past decade. In ECA, worsening demographic trends – including the shrinking size of the working-age population – add to these challenges. The report looks at migration trends and offers insights for both destination countries and countries of origin.

“Migration can contribute to prosperity in the region,” says Asli Demirguc-Kunt, World Bank Chief Economist for the Europe and Central Asia region. “Migrants disproportionately tend to be of working age and can therefore ease demographic pressures by increasing the size of the labor force, raising productivity, and boosting growth.”

Brain drain, major issue for Romania, next to non-EU states in Europe

Migration also raises concerns of ‘brain drain’ of skilled-labor from countries of origin, as people with more education tend to emigrate more often around the region. Statistics show that 55% of people with higher education from Bosnia and Herzegovina live abroad, and this figure is over 40% of the educated populations of Armenians and Latvians, and close to 40% for Albania, Moldova, North Macedonia, the Kyrgyz Republic, Kazakhstan, Romania, and Tajikistan. Such persistent patterns are often a symptom rather than the cause of the underlying problem.

WB argues that improving governance and strengthening institutions in origin countries are the long-term policies that can address the root causes of persistent emigration. Policies aimed at retaining skilled labor include promoting the private sector and boosting job creation, investing in higher education, and increasing opportunities for women in the economy. Greater connectivity is also an important aspect of increasing engagement with the diaspora, as emigrants who stay connected are more likely to invest and return. The report shows that increasing incentives for remaining in a country of origin is more likely to deter outward migration than pursuing policies that restrict benefits abroad.

Forecast for Romania’s economic growth improved to 4.7%, yet….

Although Romania’s growth was stronger than anticipated, at 4.7 percent in the first half of 2019, the economic activity was driven by private consumption, supported by an expansionary fiscal policy and a rebound in investment, the WB outlook says.

The labor market has tightened, with unemployment reaching historic lows. Increases in wages and pensions contributed to continued poverty reduction. Risks to the economic growth outlook have risen and stem from weaker demand from major exports markets, a tightening labor market and the uncertainty of fiscal policy.

Investment picked up at 12.4 percent yoy, owing to better than expected performance in construction, retail trade and services. Exports grew by 2.7 percent yoy reflecting weaker demand in the major export markets and a slowdown in industrial exports, while imports remained sturdy (up 6.4 percent) on the back of strong domestic demand. On the production side, ICT (up 9.9 percent yoy) and construction (up 14.9 percent yoy) were the main drivers of growth. Industry stagnated due to a slowdown in manufacturing and the deceleration in the dynamics of exports.

Outlook

Economic growth is expected to moderate over the medium term in line with long-term potential, as the available fiscal space shrinks and the labor market increasingly tightens. This tightening is likely to be most pronounced for tertiary educated workers, whose employment rates at 89.2 percent in Q1 2019 were twice those of workers with less than lower-secondary education. This is likely to put pressure on wage growth and to feed into rising inequality.  The fiscal measures promoted in recent years coupled with the political uncertainty in the context of a series of elections will make it unlikely that the government will be able to firmly contain imbalances. In 2019, we expect inflation to stay elevated and the external deficit to continue widening.
The government will have difficulties keeping the budget deficit within 3 percent of GDP over the medium term. The newly promoted pension law and the planned public wage increases will put endemic pressure on the consolidated budget deficit and reduce the available fiscal space for investment. The two measures would add around 0.8 percent of GDP to public expenditure in 2019, and 1.7 percent of GDP in 2020. The widening of the fiscal deficit would push public debt to 39.5 percent of GDP at end -2021, from 36.6 percent in 2018. Despite this, public debt remains one of the lowest in the EU. Strong private consumption aided by the expansionary fiscal policy and continued growth in real wages, partly supported by minimum wage increases, should continue to boost real incomes and lead to further declines in poverty incidence. The $5.50/day 2011 PPP poverty rate is projected to decline to 19.8 percent in 2019 and to 18.1 percent in 2021.

Risks and challenges

The uncertainty of fiscal policy coupled with the tightening labor market – amplified by emigration – could generate significant domestic adverse effects on growth and investment. These would be exacerbated by the expected slowdown in growth in Romania’s traditional export markets in the EU, mainly Germany and Italy. The partial decoupling dynamics of real wage and productivity could also contribute to weakening exports, putting supplementary upward pressures on the current account deficit.

Renewed efforts are needed to improve labor participation and to tackle the high unemployment among the youth and the low-skilled, helping to ease supply side constraints and improve the sustainability of growth. Over the medium term, the focus of fiscal policy should be rebalanced from boosting consumption towards mobilizing investment, primarily from EU funds, to support a sustainable EU convergence path and social inclusion. Reforms in public administration and SOEs, increased regulatory predictability, as well as policies to address the large social and spatial disparities should be on the agenda of priorities of the government.