IMF assesses Romania’s opportunities and risks in 2007

Recent reports and forecasts of international financial institutions leading bank analysts on Romania’s 2007 macroeconomic outlook indicate on the whole similar trends: widening current account deficit, solid economic growth and an inflation rate exceeding central bank’s target. Romania is expected to register a double digit current account deficit as a weight of Gross Domestic Product (GDP) as against last year’s estimated 9 per cent of GDP. The International Monetary Fund (IMF) and Standard & Poor’s both estimate the deficit will widen in 2007 to 11.9-12 per cent of GDP, while the National Bank of Romania (BNR) accepted an estimate of approximately 10 per cent.

On the other hand, in terms of economic growth, most analysts anticipate that the real GDP growth rate in 2007 will revolve around 6 per cent. The most optimistic forecasts in this respect is Global Insight’s seven per cent economic growth while ABN Amro Romania advanced the prospective lowest economic growth estimate, respectively 5.6 per cent. IMF and the National Prognosis Commission are somewhere in between, both expecting a 6.5 per cent economic growth for Romania this year. The real GDP growth rate in 2006 will revolve around eight per cent, standing for the second ever highest growth after 2004’s 8.4 per cent.

As far as the inflation rate is concerned, most analysts consider BNR will not be able to attain its targeted maximum 5 per cent consumer price increase this year. The most pessimistic forecasts come from the IMF, estimating the inflation rate will grow to around six per cent. Rating agencies Standard & Poor’s and Fitch both estimate the consumer prices will go up by 5.5 per cent as a result of the swift increase of domestic demand to be triggered by the increase of the budget deficit to 2.8 per cent and of public sector salaries. Raiffeisen advanced the most optimistic forecast in relation with the 2007 inflation rate, namely 5 per cent. In 2006, Romania managed for the first time to lower its inflation rate below the 5 per cent threshold, respectively having stood at 4.87 per cent.

Romania entered the European Union on January 1, following an impressive macroeconomic performance in 2006: inflation fell to just below 5 per cent; GDP growth was close to 8 per cent; and although the current account deficit widened considerably, it was almost fully financed by non-debt creating inflows. While a favorable external environment has certainly helped, the good performance reflects prudent monetary and fiscal policies. Looking ahead, it is important to continue with macroeconomic stabilization and structural reform, which will prepare the economy for successful EU membership, and help realize Romania’s full potential and raise living standards.

However, with the envisaged fiscal and incomes policies for this year, meeting the authorities’ key macroeconomic goals will present a challenge. The economy is already operating above capacity, and the fiscal loosening that started at the end of last year, accompanied by a loose wage policy in the public sector, will exacerbate domestic demand, and contribute to a wider current account deficit and inflationary pressures. On the basis of the government’s fiscal plans for 2007 (a general government deficit of 2.8 per cent of GDP), and the announced increases in public sector wages and the minimum wage, our baseline scenario projects continued strong GDP growth (in the order of 6.5 per cent), but also a widening of the current account deficit to around 12 per cent of GDP and inflation increasing to around 6 per cent. Such an outcome will increase the risk of a decline in competitiveness, change in market sentiment, and put in jeopardy Romania’s growth prospects.

This is the reason why we have urged the government to build on last year’s prudent macroeconomic policies by avoiding a procyclical fiscal loosening, and instead pursue fiscal and wage policies consistent with a reduction of emerging macroeconomic imbalances. Such a policy mix will help contain inflation and the current account deficit, while relieving some of the burden on monetary policy and safeguarding growth prospects.

There’s no doubt that EU membership provides a huge opportunity for Romania, but full use of it requires disciplined policy implementation. For results that were not as positive as expected after joining the EU, just witness Greece and Portugal, who have been underachievers at least for the past decade. One of the lessons derived from these experiences is that it took them a very long time to start absorbing efficiently EU funds. Romania’s difficulty in implementing its capital budget is a warning in this regard, and weaknesses in capital budget implementation should be addressed without delay—as we understand to be the intention. A reinvigoration of structural reform together with the macroeconomic policies proposed above and efficient absorption of EU transfers are the way to improved living standards in Romania and convergence of incomes with other EU members.

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