EUROPEAN COMMISSION Brussels, 22.5.2017 SWD(2017) 174 final COMMISSION STAFF WORKING DOCUMENT Accompanying the document Recommendation for a



COUNCIL RECOMMENDATION with a view to correcting the significant observed deviation from the adjustment path toward the medium-term budgetary objective



in Romania {COM(2017) 268 final}



COMMISSION STAFF WORKING DOCUMENT Accompanying the document Recommendation for a COUNCIL RECOMMENDATION with a view to correcting the significant observed deviation from the adjustment path toward the medium-term budgetary objective in Romania 1.Introduction The Council abrogated its decision on the existence of an excessive deficit in Romania on 21 June 2013, on account of the correction of Romania's excessive deficit in 2012, which, based on the Commission 2013 spring forecast, appeared durable. Since then Romania has been subject to the preventive arm of the Stability and Growth Pact, which requires sufficient progress towards the medium-term budgetary objective (MTO). Romania is not subject to the debt rule as its general government debt remains below 60% of GDP. On 12 July 2016, the Council addressed recommendations to Romania in the context of the European Semester . In particular, in the area of public finances the Council recommended Romania to limit the deviation from the MTO in 2016 and achieve an annual fiscal adjustment of 0.5% of GDP in 2017 unless the MTO is respected with a lower effort. Based on the Commission 2017 spring forecast, Section 2 of this document presents macroeconomic and fiscal developments in 2016-17. Section 3 presents an assessment of compliance with the obligations stemming from the Stability and Growth Pact, including an overall assessment of the reasons for the deviation from the requirements of the preventive arm. Section 4 proposes a fiscal effort for 2017 to address the significant deviation, including a new applicable expenditure benchmark rate compatible with the suggested annual improvement in the structural balance. Section 5 provides the overall conclusions. 2.Macroeconomic and fiscal developments in 2016 In 2016, real GDP growth rose to an eight-year high of 4.8%, driven mainly by consumption, which was boosted by expansionary fiscal policy and wage hikes. Investment, by contrast, contracted as public investment fell following a slow uptake of new projects financed by EU funds in the 2014-2020 programming period. The contribution of net exports to growth was negative, as imports outpaced exports on the back of strong consumption growth. An additional, sizeable although smaller fiscal stimulus planned in 2017 is projected to continue to support domestic demand and growth, but at a slower pace as the transitory effects of the fiscal impulse of 2016 wear out. Growth is expected to remain consumption-driven, boosted by tax cuts and increases in public wages and pensions. Investment is forecast to make a modest contribution to growth as the implementation of projects financed from EU funds gradually picks up. The labour market continued to improve in 2016 on the back of strong real GDP growth. Unemployment dropped to a historical low in 2016. Low unemployment, combined with a shrinking labour force and persistent skills shortages, led to a tighter labour market and economy-wide wage increases. Total employment decreased in 2016 as the decline in self-employment more than offset the increasing number of employees. Total employment is set to increase at a moderate pace in 2017 and 2018 due to high inactivity rates and negative demographics, driven by strong growth, while the unemployment rate is projected to continue to decline. The growth of compensation per employee accelerated in 2016, on the back of increases in the minimum wage and public sector wages. The main risk to the outlook is the possibility of a further fiscal stimulus in line with the government programme, which may boost domestic demand in the short-run, but at the expense of posing additional risk to the sustainability of public finances. In the absence of structural reforms to support competiveness, potential growth would be constrained. Table 1. Macroeconomic developments and forecast





In 2016, the general government deficit rose to 3% of GDP, from 0.8% of GDP in 2015, while the economy grew above its potential. Tax cuts, particularly a four percentage point cut in the standard VAT rate, had a negative effect on tax revenues. On the expenditure side, public wages were considerably increased. The 2016 budget outcome was slightly worse than the 2016 Convergence Programme target of a deficit of 2.9% of GDP. Both the revenues and the expenditures turned out lower than planned in the 2016 Convergence Programme. On the revenue side, the indirect tax revenues target was not achieved. On the expenditure side, public investment was significantly lower than planned. The Commission 2017 spring forecast projects the headline deficit to increase to 3.5% of GDP in 2017. The standard VAT rate was cut by an additional one percentage point. Moreover, part of the excise duty on fuel and a special construction tax were abolished. The 2017 budget contains significant increases of public wages and social benefits, including an additional pension increase of 9%, scheduled for July 2017, on top of the standard indexation. The Romanian authorities in the 2017 Convergence Programme plan a headline deficit of 2.9% of GDP in 2017. The overall revenues and expenditures ratios are higher than in the Commission forecast. The underlying macroeconomic projection of 5.2% of real GDP growth is more optimistic than the Commission projection, with a positive impact on tax revenues. The projection of revenues from all categories of taxes and social contributions is higher than in the Commission forecast (see Table 2). On the expenditure side, public wages and social contributions are lower than in the Commission forecast, while planned public investment is significantly higher. The lower public investment projection in the Commission forecast takes into account (i) a systematic under-execution in the previous years, (ii) the weak budgetary outturn in the first quarter of 2017, and (iii) a more prudent assumption on the military equipment deliveries in 2017. The planned unified wage law (UWL), currently debated by the parliament, poses a significant risk to the fiscal forecast in 2018 and beyond, with a potential impact on the general government balance of up to -2% of GDP in 2018. Its final form and implementation schedule were not known at the cut-off date of the Commission spring 2017 forecast. Therefore, the UWL has not been included in the Commission spring 2017 forecast, nor in the 2017 Convergence Programme projection.



Table 2. Composition of the budgetary adjustment



Table 3. Debt developments In 2016, the general government debt-to-GDP ratio decreased by 0.4% of GDP, reaching 37.6% and is projected by the Commission to increase to 40.9% of GDP by 2018. 3.Compliance with the adjustment towards the MTO Romania's MTO is a deficit of 1% of GDP in structural terms. On 12 July 2016, the Council addressed recommendations to Romania in the context of the European Semester. In the area of public finances the Council recommended Romania to limit the deviation from the MTO in 2016 and achieve an annual fiscal adjustment of 0.5 % of GDP in 2017 unless the MTO is respected with a lower effort. That recommendation is in line with the earlier Council recommendation from 14 July 2015, which required Romania to remain at the MTO in 2016. On 22 February 2017 Vice-President Valdis Dombrovskis and Commissioner Pierre Moscovici sent a joint letter to the Romanian authorities in which they recalled that Romania was estimated to have significantly deviated from its MTO in 2016, while the Commission forecast pointed to further deterioration of the structural balance in 2017 and 2018. The letter also pointed to a clear risk, based on the Commission forecast for 2017 and 2018, that the deficit criterion for the purposes of the Treaty and of Regulation (EC) No 1467/97 would not be fulfilled. The letter recalled that the Commission would reassess Romania's compliance with its obligations under the Stability and Growth Pact on the basis of the Commission 2017 Spring Forecast, including the budgetary data for 2016 and Romania's 2017 Convergence Programme. It recalled the importance that the necessary measures to ensure compliance with the deficit criterion and with the adjustment path towards the MTO were credibly announced by that time. In 2016, from a position of -0.6% of GDP in 2015, i.e. above the MTO, the structural balance deteriorated to -2.6% of GDP, pointing to a significant deviation from the recommended structural adjustment by a large margin (deviation of 1.6% of GDP). The growth of government expenditure, net of discretionary revenue measures and one-offs, was well above the expenditure benchmark, also pointing to a significant deviation by a large margin (deviation of -2.0% of GDP). The difference in the indicators is mainly explained by different annual nominal potential GDP growth rates used in their computation. Irrespective of that difference, both indicators confirm a significant deviation from the requirements in 2016.