IMF Executive Board Concludes 2021 Article IV Consultation with Romania

Washington, DC: On August 26, 2021, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation^[1]with Romania, and considered and endorsed the staff appraisal without a meeting.[2]

The Romanian economy fared relatively well during the COVID-19 crisis, as the GDP contraction in 2020 (-3.9 percent) was significantly milder than the EU average (-6.2 percent). Effective and timely fiscal, monetary and financial policy easing helped to curb the economic downturn and the rise in unemployment. Private consumption and net exports led the decline in 2020, while gross fixed capital formation continued to expand, supported by a pickup in public investment. As a result of pandemic-induced economic disruptions, wage growth slowed substantially, and inflation declined into the lower half of the target band. The fiscal deficit widened markedly to 9.7 percent of GDP to accommodate the crisis support package that comprised measures similar to those in EU peers, including emergency health care expenditures, income support for households as well as support for the affected businesses. Monetary and financial sector policy easing played an important role in ensuring market functioning.

A strong economic recovery is underway in 2021. GDP growth has rebounded sharply, reaching 4.6 percent and 2.8 percent (q/q) in Q4 2020 and Q1 2021—among the strongest pickups in the EU—with output in Q1 2021 surpassing the pre-pandemic peak. Headline inflation has increased, partly reflecting higher energy prices. Nonetheless, inflation expectations remain well-anchored within the target band. Concurrently with the recovery, the current account deficit has widened.

Real GDP growth is projected at 7 percent in 2021, led by private consumption and accompanied by a transitory increase in inflation. Over the medium term, output is projected to recover to its pre-pandemic trajectory, as protracted scarring from the pandemic is expected to be contained. Public investment will be boosted by a pickup of EU-funded projects, including through new resources under the NGEU funds and the EU 2021-27 multiannual budget. The current account deficit is projected to narrow moderately into the medium term as fiscal consolidation proceeds and growth decelerates toward potential.

Executive Board Assessment

Following a relatively mild contraction during the COVID-19 crisis, a strong recovery is underway. The output contraction in 2020 was among the mildest in the EU, helped by effective and timely fiscal and monetary policy responses. Output in Q1 2021 surpassed the pre-pandemic peak and growth for the year is projected at 7 percent. Nevertheless, downside risks remain, including uncertainty about the evolution of the pandemic.

Policy support should shift towards the most affected sectors. Ensuring a speedy vaccine rollout is the most important economic policy to address the pandemic, for which continued generous fiscal resources need to be ensured. Although the broad-based fiscal support measures for incomes and businesses have successfully contained the aggregate economic fallout from the pandemic, the most severely hit sections of the economy continue to be disproportionately impacted. Accordingly, the pandemic support measures should be shifted towards the most affected sectors and disadvantaged groups. At the same time, if the recovery surprises on the upside, the authorities should save the windfall revenues.

As the recovery becomes entrenched, fiscal policy should increasingly prioritize rebuilding space for fiscal maneuver. The 2021 budget appropriately lays the foundation for fiscal consolidation, but significant additional medium-term consolidation efforts will be needed to reduce the deficit to the authorities’ target of 3 percent of GDP. The revenue base should be broadened, and revenue administration strengthened to achieve a more equitable distribution of the tax burden and improve tax efficiency. Expenditures should be reprioritized by boosting public investment, while ensuring a sustainable medium-term trajectory for wage and pension spending.

To continue raising incomes towards average EU levels, the authorities should re-energize efforts to overcome subpar governance and government effectiveness . SOE reforms, starting with the strengthening of corporate governance, would help to address these challenges. Governance improvements are integral to reforms of revenue administration. Governance gains are also paramount to improving and speeding up public investment. Strengthening of the anti-corruption framework and ensuring robust implementation (including of the AML/CFT framework) are essential.

Romania should take full advantage of the historic opportunity provided by the RRF grants and EU structural funds, with a total envelope of 20 percent of GDP over the next six years. Successful implementation of RRF reform commitments and investment projects would boost Romania’s medium-term growth prospects. Through its focus on digitalization, the RRF should provide critical support for modernizing tax administration. It should also be used to jumpstart efforts to address climate change.

Monetary and financial sector policies should remain accommodative. The National Bank of Romania should sustain monetary and financial accommodation to support the recovery and cushion the impact of fiscal consolidation, while monitoring inflationary risks. If bank asset quality deteriorates, the NBR should balance accommodating stance and prudential concerns. Preparations should be in place to handle any deterioration in bank asset quality once the relief measures expire and ensure efficient insolvency procedures. Once the crisis recedes, exchange rate flexibility should be gradually increased, to absorb external shocks and help address the current account deficit.