EUROPEAN COMMISSION Brussels, 26.2.2020 SWD(2020) 522 final COMMISSION STAFF WORKING DOCUMENT Country Report Romania 2020 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2020 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2020) 150 final}



Contents Executive summary 1.Economic situation and outlook 2.Progress with country-specific recommendations 3.Summary of the main findings from the MIP in-depth review 4.Reform priorities 4.1.Public finances and taxation 4.2.Financial sector 4.3.Labour market, education and social policies 4.4. Competitiveness, reforms and investment 4.5.Environmental Sustainability Annex A: Overview Table Annex B: Commission debt sustainability analysis and fiscal risks Annex C: Standard Tables Annex D: Investment guidance on Just Transition Fund 2021-2027 for Romania Annex E: Progress towards the Sustainable Development Goals (SDGs) References LIST OF Tables

Table 1.1:Key economic and financial indicators Table 2.1:Assessment of 2019 CSR implementation Table 3.1:MIP assessment matrix (*) - Romania 2020 Table C.1:Financial market indicators Table C.2:Headline Social Scoreboard indicators Table C.3:Labour market and education indicators Table C.4:Social inclusion and health indicators Table C.5:Product market performance and policy indicators Table C.6:Green growth LIST OF Graphs Graph 1.1: GDP growth and demand-side components Graph 1.2: Industrial production Graph 1.3: Contribution to potential growth Graph 1.4: Disparities between Romanian regions Graph 1.5: Demographic change in Romania Graph 1.6: Labour market overview 11 Graph 1.7: Current account breakdown and capital account Graph 1.8: Harmonised index of consumer prices (HICP) Graph 1.9: General government balance and output gap

Graph 1.10: 10 year government bond yield: Romania and peers Graph 1.11: Loans to households and non-financial corporations Graph 2.1: Overall multiannual implementation of 2011-2019 CSRs to date Graph 4.1.1: Drivers of change of general government balance Graph 4.1.2: Gross public pension expenditure in 2018-2022 Graph 4.1.3: Redistributive power of the tax and benefit systems in EU Member States, 2017 Graph 4.3.1: Demographic growth and working age population Graph 4.3.2: Developments in hiring Graph 4.3.3: Outpatient use vs inpatient use Graph 4.3.4: Income inequality in Romania - S80/S20 income quintile share ratio Graph 4.3.5: Severe material deprivation rate for children by educational attainment level of their parents Graph 4.4.1: Net international investment position Graph 4.4.2: Trade balance breakdown Graph 4.4.3: Export market share by industry Graph 4.4.4: RON-denominated export price evolution Graph 4.4.5: Real effective exchange rate growth Graph 4.4.6: Nominal unit labour cost Graph 4.4.7: Value added and average labour productivity growth by manufacturing technology class Graph 4.4.8: World rank of Romanian transport infrastructure on 13 indicators Graph 4.4.9: Social needs - income distribution per region

Graph 4.4.10: Ease of Doing Business (2019) Graph 4.5.1: EU highest GHG emissions per GDP in 2017 Graph 4.5.2: GHG emissions in Romania by sector LIST OF Boxes Box 2.1: EU funds and programmes to address structural challenges and to foster growth and competitiveness in Romania Box 4.1.1: New pension law: pension adequacy and budgetary sustainability Box 4.3.1: Monitoring performance in light of the European Pillar of Social Rights Box 4.4.1: Investment challenges and reforms in Romania Executive summary In the absence of lasting reform efforts, growing fiscal and current account deficits are putting the sustainability of Romania’s economic growth at risk. Strong domestic demand, stimulated by tax cuts and large wage increases, has been the economy’s growth engine in recent years. This consumption-led growth model has pushed the country’s current account and public finances into rising deficits. In addition, adverse demographic developments have led to significant labour and skill shortages, limiting the country’s growth potential. Despite an average growth of around 5% in the past three years, inequality is increasing and poverty remains high, while regional disparities are deepening. Without a correction of the fiscal and external deficits and a firm commitment to implement structural reforms, Romania’s convergence towards EU living standards is likely to suffer important set-backs (). The economy continues to grow, albeit at a slower pace. Real GDP growth remained robust in 2019 at 4.1% on the back of private consumption, with investment providing support. Growth is forecast to ease to 3.6% and 3.3% in 2020 and 2021 respectively, due to weaker industrial production and a softening external demand. The fiscal-led boom in domestic demand continues, further widening the current account deficit. With strong private-consumption led import growth outpacing exports, the current account deficit is set to deteriorate to 5.1% in 2019 and is expected to increase to 5.4% in 2021. The labour market continued to tighten, while significant challenges remain. A very low labour force participation rate and a decline of the active population, due to demographic changes, including emigration, have resulted in labour force and skill shortages and mismatches. Labour activation policies and adult learning programmes are not effective in responding to such needs. At the same time, skill mismatches are deepening, while technological development generates a shift in the demand for skills. Social dialogue remains limited. Wages remain low compared to the EU average but have been growing rapidly, supporting employees’ purchasing power. The sustained wage growth, strongly outpacing productivity increases, may pose risks to competitiveness in the future. The public deficit has risen sizably, driven by current expenditure. The public deficit continued to increase, above the 3% of GDP Treaty threshold in 2019, driven by current spending. It is projected to widen further, in particular due to a 40% pension indexation scheduled for September 2020. As in previous years, the rules of the national fiscal framework have not been respected. A high public deficit and increasing ageing costs result in high fiscal sustainability risks. The banking sector has remained solid, but financial intermediation is low. Some damaging provisions to the financial sector in December 2018 were amended in 2019 and 2020, favouring banks’ resilience and a stable capitalisation, above the EU average. However, banks only play a limited role in providing credit to corporates, which may be holding back the economy. Insufficient investment hampers the potential of the economy to converge to EU levels. The quality and reliability of the road and rail networks is poor. Investment in sustainable transport, energy and environmental infrastructure (i.e. in waste, wastewater and air pollution) is lacking. The energy, waste, wastewater infrastructure continue to need an important investment push. Prioritisation, stabilisation and increases of public and private investment in research, development and innovation and in physical and digital infrastructure would contribute to reduce regional disparities and improve productivity and long-term growth. Romania has made limited () progress in addressing the 2019 country-specific recommendations. There has been substantial progress in:

·Safeguarding financial stability and the robustness of the banking sector. There has been some progress in the following areas: ·Ensuring the long-term viability of the second pension pillar; ·Implementing the national public procurement strategy. There has been limited progress in the following areas: ·Efforts to strengthen tax compliance and collection; ·Improving the quality and inclusiveness of education; ·Increasing the coverage and quality of social services; ·Improving social dialogue; ·Developing a minimum wage setting mechanism based on objective criteria; ·Improving access and cost-efficiency of healthcare; ·Focusing investments on key policy areas and strengthening project prioritisation and preparation in public investment. There has been no progress in the following areas: ·Ensuring that the national fiscal framework is implemented; ·Ensuring the sustainability of the public pension system; ·Improving skills by increasing the labour market relevance of vocational education and training and higher education; ·Completing the minimum inclusion income reform; ·Improving the predictability of decision making; ·Improving the corporate governance of state-owned enterprises. The Social Scoreboard supporting the European Pillar of Social Rights points to a number of employment and social challenges. High economic growth has translated into improved social conditions. However, poverty and social exclusion, as well as in-work poverty, remain very high while income inequalities have increased. Social transfers have a limited impact on poverty reduction. Inequalities persist, in particular for people in rural and disadvantaged areas. The inactivity rate for women and early school leaving are also very high. The decentralisation of social services has not been accompanied by the provision of proper financial allocations, thus hampering the sustainability of service delivery. The coverage of public services remains low. The de-institutionalisation of children continues to show encouraging progress.

Romania recorded positive progress towards most of its national targets of the Europe 2020 strategy. Romania is performing well on employment rates, national greenhouse gas emissions, renewable-energy levels, energy efficiency and tertiary education. R&D investment and early school leaving remain some distance away from their respective targets. In terms of the United Nations’ Sustainable Development Goals (SDGs), Romania continues its progress towards EU levels (). In climate action (SDG13) Romania is below EU-average levels in greenhouse gas emissions, energy and renewable-energy consumption. In quality education (SDG4) however, Romania is performing particularly poorly with respect to the EU-average levels, with high numbers of early school-leavers and young people neither in education, employment or training. However some improvement can be observed in terms of trends. The main findings of the in-depth review contained in this report and the related policy challenges are as follows: ·Romania’s current account deficit continued to widen and its financing raises concerns. The current account deficit is expected to continue increasing due to strong import dynamics rather than poor export performance. The composition of imports, tilted towards consumption goods, does not support long-term economic growth. The coverage of the growing current account deficit by foreign direct investments has been declining and past improvements in the net international investment position have recently started to show signs of reversal. ·The risks to Romania’s competitiveness come from both cost and non-cost factors. Labour cost growth has eased but remains among the highest in the EU. Wage increases continue to outpace solid productivity growth, also in sectors integrated in global value chains and open to international trade. The labour cost based real effective exchange rate has appreciated, although at a slower pace. Furthermore, non-cost factors such as the poor quality of infrastructure, the economy’s low innovative capacity and poor institutional quality hinder the country’s ability to compete internationally. ·Some of the main risks to the financial sector created by the December 2018 legislation have been averted, but some concerns remain. The tax on banks’ assets was eliminated. As regards the second pension pillar, the possibility to opt out was removed and the additional minimum capital requirements for fund management companies cancelled. However, the overall perception of legislative unpredictability affecting the financial sector persists. ·Policy unpredictability continued in 2019, still some progress was made on executing the national public procurement strategy. Persistent uncertainty about policy and legislative decisions contributed to an overall perception of unpredictability in public policymaking. Increased legislative stability and quality of legislative proposals, together with an improved communication on the country’s reform direction would help businesses anchor investment decisions. Despite improved implementation, public-procurement efficiency remains an issue, and the irreversibility of certain measures should be further monitored. Other key structural issues analysed in this report, which point to particular challenges for Romania’s economy, are the following: ·Adverse demographics and existing structural deficiencies require labour activation and upskilling measures. The persistent negative population growth and the outward migration of skilled labour generated significant labour force shortages. Inactivity has declined but remains one of the highest in the EU especially for women. It also varies considerably across regions and social groups, which indicates a low adequacy and effectiveness of activation measures. Without targeted upskilling and re-skilling measures based on a comprehensive skills forecasting mechanism, the supply of certain skills might become scarce. ·Poverty and inequality remain high, with limited access to services. One in three Romanians is at risk of poverty or social exclusion, with vulnerable groups, including the Roma, being the most exposed. Child poverty and educational attainment are closely linked to parents’ income. In-work poverty is among the highest in the EU while social benefits and minimum income are failing to reduce poverty. Despite a rapidly ageing population, active ageing measures are missing. Access to services still faces challenges, deepening the rural-urban divide, regional disparities and inequalities. The potential of the social economy to improve social conditions is insufficiently used. ·The equity, inclusiveness and quality of education remain important challenges. Education spending is amongst the lowest in the EU. Early school leaving is very high, in particular for pupils in rural areas, Roma children and children with disabilities. An integrated, nation-wide strategy targeting early school leaving is not yet in place. Educational outcomes, especially in rural and economically deprived areas, are not improving. The acquisition of digital skills is low, posing challenges for the future labour market integration of graduates. The labour market relevance of vocational education and training and higher education remains low, harming graduates’ job perspectives. ·The healthcare system is not effective in improving neither accessibility nor the health of the population. Unmet medical needs have increased, with high urban-rural gaps and low coverage for low income groups and the elderly. Preventive, outpatient and community based care remain under-financed and not covered by sufficiently targeted public policy measures. The health status of the population remains below the EU average. Total healthcare spending is low and focused on inpatient care. Population ageing and migration are putting increasing pressure on the sustainability of the healthcare system. ·Regional disparities in Romania are amongst the highest in the EU. Significant gaps across regions persist in investment, productivity, competitiveness and employment. Addressing them and prioritising investment at a regional level would help increase the country’s competitiveness and support long-term growth, development and modernisation. ·Romania’s weak research and innovation performance hampers the transition towards a knowledge-based economy. The country continues to have one of the lowest levels of public and private expenditure on research and development in the EU, negatively affecting scientific quality and the diffusion of technology amongst firms. Increasing R&D investment and quality and supporting innovative firms remain important challenges. ·The reform of the public administration is stalling, still some progress was made on executing the national public procurement strategy. There has been little progress in decision-making and the quality and effective use of regulatory impact assessments. The development of an effective framework for strategic and budgetary planning has stalled. Red tape and an insufficient capacity to deliver quality services, including digital, are negatively impacting on citizens and businesses. Frequent reorganisations and overuse of temporary management hamper the independence of the administration. High fragmentation of competencies and resources continue to affect the delivery of public services, especially at local level and in poor communities. Public-procurement efficiency remains an issue, and the irreversibility of certain measures should be further monitored. ·The implementation of corporate governance for state-owned enterprises has shown no significant progress. There has been a deterioration in the operational and financial performance of state-owned enterprises in 2018 and the first half of 2019. ·Corruption continues to be a major problem for the business environment in Romania. While the government currently supports actions to prevent and sanction corruption, Romania is facing important challenges to restore progress in the fight against corruption following damages done in the past years through legislative amendments and continued pressure on judicial institutions. ·Substantial challenges remain regarding air pollution, climate change mitigation and adaptation. Greenhouse-gas emissions not covered by the EU trading system are set to increase, deviating from the 2030 target. Curbing emissions from transport, buildings and agriculture will be key in reaching the target. Investment in green technologies and sustainable solutions, and securing adequate funding will be key to deliver on the climate and energy objectives and shape a new growth model. The Commission’s proposal for a Just Transition Mechanism under the next multi-annual financial framework for the period 2021-2027, includes a Just Transition Fund, a dedicated just transition scheme under InvestEU, and a new public sector loan facility with the EIB. Designed to ensure a fair transition towards EU climate neutrality, it will help the most affected regions to address the social and economic consequences. Key priorities for support by the Just Transition Fund, set up as part of the Just Transition Mechanism, are identified in Annex D. 1. Economic situation and outlook GDP and potential growth

Growth remained robust in 2019, close to the previous year’s level. Real GDP is estimated to have increased by 3.9% in 2019, as a result of strong consumer spending and recovering investment (Graph 1.1). After a drop in 2018, gross fixed capital formation is expected to have contributed positively to growth in 2019, bolstered mainly by a booming construction sector. Net exports’ contribution to growth is expected to have remained negative, as softer external demand slowed the dynamics of exports, while imports were still supported by resilient domestic demand. Graph 1.1:GDP growth and demand-side components 2019-2021: Winter forecast 2020 for real GDP growth, otherwise Autumn forecast 2019 Source: European Commission Growth is expected to ease off progressively over the medium term. Real GDP growth is set to decelerate to 3.8% in 2020 and to 3.5% in 2021, with consumer spending as the main driver of growth. Net exports are forecast to remain a drag on growth, but slightly less so than in 2019. Lastly, the contribution of investment is expected to stay positive, albeit at lower levels, over the coming years, supported by construction and an acceleration in the absorption of EU funds. Industrial production began to contract in 2019. Between the end of 2017 and the end of 2018, the growth rate of industrial production fell by almost 10 percentage points and turned negative in Q2-2019. Manufacturing declined by 1.6% over the first three quarters of 2019. The manufacturing of consumer goods has decreased every month since September 2018, while for capital goods production entered a contraction period in April 2019. At the end of Q3-2019, more than 70,000 jobs had been lost in the manufacturing sector compared to the corresponding quarter of 2018. The degree of capacity utilisation in manufacturing began to contract in Q4-2018 (Graph 1.2). Graph 1.2:Industrial production Source: European Commission Potential growth is largely driven by total factor productivity and risks being hampered by demographic trends. Potential GDP growth is expected to have declined slightly in 2019 and continue to decrease thereafter. Total factor productivity is projected to decelerate, but remain the main growth contributor. The contribution of capital accumulation is projected to remain broadly stable. On the other hand, the already modest contribution of labour is forecast to turn increasingly negative, mainly due to the constant decrease in working age population (Graph 1.3). Graph 1.3:Contribution to potential growth Source: European Commission Regional disparities GDP per head continues to converge with the EU average but regional disparities persist. Income disparities are among the highest in the EU, mainly driven by the large gap between the capital region of Bucharest and the rest of the country. In five of the eight Romanian development regions (NUTS 2 regions), GDP per head grew faster than the EU average, while the three poorest regions saw their GDP per head shrink between 2011 and 2017. In the capital region, GDP per head corresponds to 144% of the EU average and has grown the fastest over the last six years. At 67% of the EU average, the Vest region has the second highest GDP per head in Romania. In the other Romanian regions, GDP per head ranges from 39% to 60% of the EU average (Graph 1.4). Labour productivity differences between regions remain significant. Labour productivity in the capital region of Bucharest stands at 122% of the EU average, compared to just 73% in the Vest region, the second most productive (Graph 1.4). Differences in productivity growth rates are also significant. Between 2010 and 2016, real productivity grew fastest in the Vest (8.3%) and Sud-Est (6.5%) regions, followed by the capital region (6.4%). The other regions saw lower productivity growth, but still above the EU average (0.8%), with the exception of Nord-Est, where productivity shrunk by 1.4% per year. Graph 1.4:Disparities between Romanian regions Source: European Commission Investment levels are highly uneven. Less developed regions need a high level of public and private investment in order to catch up with the more developed regions. Between 2014 and 2016, investment in the Bucharest region, measured as gross fixed capital formation as a percentage of GDP, was almost twice the EU average, while in the other regions investment hovered around the EU average. Apart from the capital region, the level of investment was above the EU average in only two other regions, Nord-Vest and Centru. Rural-urban disparities remain significant. Positive labour market developments are not benefitting all regions and population groups equally. The at-risk-of-poverty rate in rural areas is almost five times higher than in cities. Large regional disparities are detrimental to long-term sustainable growth. Regions with significant shares of the workforce concentrated in low-productivity sectors are characterised by relatively low salaries and high poverty rates, which have a negative impact on social cohesion. Demography Romania’s population has decreased over recent decades and is projected to shrink further. It has fallen by 3.8 million since 1990 and is projected to fall to 15 million by 2070 (Graph 1.5), from the current level of 19.4 million, driven by demographic change, including emigration. As a consequence, the old-age dependency ratio, i.e. the ratio of people aged 65+ relative to people of working-age (15-64), is projected to double from 26.3% in 2016 to 52.8% in 2070. This implies that the number of working-age people for every person aged over 65 would fall from almost four to just two. Population ageing has a negative impact on the adequacy of pensions and on future spending on healthcare and the long-term sustainability of public finances. Graph 1.5:Demographic change in Romania Source: European Commission Labour market, poverty and social inclusion On the back of positive economic developments, labour market conditions remain tight. Since 2017, there has been a general pick-up in employment, with an increase of 0.2% in 2018 (Graph 1.6), to a record employment rate of 70.8% in Q3-2019. This trend is expected to continue with employment growing further in 2019 and 2020. The unemployment rate fell to 3.9% in 2019, its lowest level since 1997. Despite the overall positive labour market performance, a number of challenges remain. Romania has one of the lowest labour force participation rates in the EU and its working-age population has been declining steadily since 2008, while labour and skills shortages have been increasing. At the same time, the percentage of young people not in education, employment or training (NEET), standing at 14.5% in 2018, is one of the highest in the EU. The activity rate (for ages 15-64 years) is still among the lowest in the EU, in particular for women (58.7% in Q3 2019, compared to 77.9% for men) and people with low educational attainment (43.8% in Q3 2019 vs 88.8% among those with high educational attainment). Activation measures are not fully effective, especially in the case of vulnerable groups. The weak functioning of social dialogue does not adequately involve social partners in the design and implementation of reforms. Graph 1.6:Labour market overview Source: European Commission

Wages have increased significantly in Romania in recent years. Nominal wages continued to grow at a fast pace. As they grew more than inflation, real wages also increased, boosting employees’ purchasing power. Wages remain low compared to the EU average and relatively high wage growth is to be expected from a catching-up economy. Public wages more than doubled between Q1-2015 and Q2-2019 and have significantly outpaced wages in the private sector, but they are expected to slow down in 2020. The minimum wage has also been increased markedly. While not yet directly visible, the sustained pace of wage growth may nonetheless pose risks to competitiveness in the future, if wages continue to increase ahead of productivity. Poverty continued to decline but inequality has deepened. Despite higher wages and pensions, income inequality increased in 2018 following a two-year decline, while slightly decreasing in almost all Member States. The income share of the poorest 40% of the population, already one of the lowest in the EU, decreased. Despite a further decline in 2018, the percentage of people at risk of poverty or social exclusion was still among the highest in the EU, with one in three Romanians still at risk of poverty or social exclusion. In 2018, in-work poverty dropped, but it still stands at 15.3%. Poverty risks affect rural areas and vulnerable groups more strongly and tend to be associated with low educational attainment and unfavourable socio-economic status. Child poverty remains among the highest in the EU, affecting 38.1% of children compared to an EU average of 24.3%. Social transfers have a very low impact on poverty reduction (European Commission, 2019d). Investment After a modest performance in 2018, total investment recovered in 2019, increasing by more than 18% in the first three quarters of the year. In 2018, total investment accounted for 21.0% of GDP, above the EU and peer countriesʼ averages of 20.3% and 20.9% respectively. Private investment has dropped to 18.3% of GDP but remained above the averages for the rest of the EU and peer countries. Meanwhile, public investment slightly recovered from the post-EU accession low in 2017, increasing to 2.7% of GDP (see Section 4.4). However, it remained below the EU average and much below the average of the neighbouring countries. Total investment recovered in 2019, increasing by more than 17% in the first three quarters of the year. It is expected to remain relatively robust thanks to construction investment and an acceleration of spending on projects co-funded by the EU towards the end of the current programming period. Investment could be negatively affected by persistent uncertainty. Continued unpredictability of public policies could hinder business confidence and investment decisions (see Section 4.4.5). Budgetary pressures resulting from the new pension law (see Box 4.1.1) also pose a downward risk to public investment. External position The current account deficit deteriorated further in 2019 on the back of strong domestic demand fuelling imports. Following a sharp increase in 2018 to -4.4% of GDP, the current account deficit is estimated to have further deteriorated to -5.1% of GDP in 2019 (Graph 1.7). The worsening of the goods trade balance was the main determinant of this evolution, with trade deficits in intermediate and consumer goods being the two main drivers. The deficits were the result of imports still advancing faster than exports. The slowdown in the growth of the surplus in services also contributed to this trend. Overall, export perform well and market shares increased. As in 2018, the current account balance continues to diverge from the values supported by the economy’s fundamentals, which imply a balanced position (). Graph 1.7:Current account breakdown and capital account Source: European Commission After years of improvement the net international investment position shows signs of setback. From a trough of some -68% of GDP in 2012 the net international investment position reached -43.7% of GDP in 2018 but slightly worsened to -44.3% in Q3-2019, following the deterioration of the current account balance. This evolution could continue as GDP growth slows and the current account deficit is expected to widen further. A positive capital account balance has partly mitigated, but not fully offset, the country’s net borrowing as a whole. Past improvement was driven by a marked reduction of other investment (loans, currency and deposits, trade credit). More recently, portfolio investment picked up while the reserve assets declined somewhat (see Section 4.4.1). Inflation and monetary policy Inflation edges down but remains among the highest in the EU. After a peak of 4.7% in September 2018, the harmonised index of consumer prices (HICP) started to ease and inched slightly below 3.9% in 2019, still among the highest in the EU (Graph 1.8). The decline in HICP inflation was largely due to the fall in energy prices, on account of international oil price developments. Despite the moderate decrease in headline inflation, core inflation (i.e. excluding energy and unprocessed food) remained high throughout 2019, at an average of 3.8%, supported by strong wage growth. In the medium term, headline inflation is expected to decrease moderately, to 3.4% in 2020 and 3.3% in 2021, thus re-entering the National Bank of Romania’s (NBR) inflation target band (2.5% ± 1 pp.). The NBR maintained its policy rate at 2.5% throughout 2019 and at the beginning of 2020, while applying strict control over money market liquidity to counter inflationary pressures. Graph 1.8:Harmonised index of consumer prices (HICP) Source: European Commission, National Bank of Romania Public finances The public deficit has been widening, driven by higher current spending. The headline deficit is projected to have risen from 2.9% in 2018 to 3.6% of GDP in 2019, mostly driven by public wage expenditure. The headline deficit is set to continue widening, to 4.4% of GDP in 2020 and 6.1% of GDP in 2021, due to significant increases in old age pensions enacted in summer 2019 (see Box 4.1.1). The structural deficit () is projected to rise, to close to 6% of potential GDP in 2021 (Graph 1.9). Graph 1.9:General government balance and output gap Source: Eurostat, European Commission 2019 Autumn Economic Forecast General government debt is projected to increase. Because of the widening of the public deficit, the general government debt is set to rise from 35% of GDP in 2018 to 40.6% of GDP in 2021. Assuming no policy change, the debt is set to increase above 90% of GDP by 2030. The financing cost of public debt is well above those observed for peer countries (Graph 1.10). Financial markets’ perceptions of sovereign risk are at the lower limit of the investment grade, with a ‘BBB-’ or equivalent rating of the sovereign debt from the three major rating agencies. On 10 December 2019, S&P Global Ratings revised its outlook on Romania from stable to negative, due to its budgetary stance (Section 4.1.4). Graph 1.10:10 year government bond yield: Romania and peers Source: European Commission Financial sector The banking sector’s capitalisation is above the EU average, but some vulnerabilities persist. While banking sector capitalisation and funding have remained robust, some signs of asset deterioration have resurfaced with increasing new non-performing loans (NPL), even though the gross NPL ratio at system-level further decreased. The bank-sovereign nexus has remained significant, as government bond holdings represent almost 18% of total assets in the banking sector, with a marked home bias, compared to a 3.2% average for euro area banks. The level of financial intermediation in 2018 was 25.6% of GDP, below the EU average, limited by legislative changes and weaknesses in the corporate sector. Total credit continued growing in 2019 but at slower pace. Credit activity expanded more markedly from the end of 2017, when economic growth peaked in Romania. In terms of composition, around 75% of the credit went to the domestic private sector and around 20% were loans to non-residents in 2019. A decreasing share of 2.8% went to the public sector. In terms of private credit composition, households continued to account for the bulk of banks’ credit allocation, despite a slow deceleration in 2019 (Graph 1.11). Loans to non-financial corporations remained broadly stable after an acceleration at the end of 2018 and beginning of 2019.

Graph 1.11:Loans to households and non-financial corporations Source: National Bank of Romania Private credit remained relatively steady in 2019 but growth performance was tilted towards foreign currencies. As a share, all types of currency loans remained broadly unchanged in 2019. However, the private sector seems to demand less credit denominated in domestic currency while loans denominated in foreign currencies, mainly in euro, accelerated in 2019, especially for non-financial corporations. Foreign-currency denominated loans to corporations grew at the beginning of 2019 for the first time since 2016 (NBR, 2019). Over the last 10 years, the distribution of household credit between housing and consumer loans has inverted. In 2009, just 23% of such loans were for housing purposes. Since 2016, credit to households for housing loans has outweighed consumer loans. In 2019, this trend continued, fuelled by increases in disposable income and public support measures for mortgage lending such as the Prima casa (First Home) programme (see Section 4.2). Housing market Residential construction saw strong growth while house prices were quite stable. In the third quarter of 2019 residential construction activity recorded a 33.1% expansion in annual terms, in stark contrast to the loss of steam that characterised the sector in 2018. The development was supported by the rise in household income and by a cut in the VAT rate to 5% for second-home purchases. Growth in the sector is forecast also to continue in 2020, as indicated by positive consumers’ intention. Following healthy growth rates in the first half of 2018, house prices stagnated in the second part of the year. Prices started picking up again in the first half of 2019. Progress towards the SDGs () Romania is making progress towards achieving the United Nations’ Sustainable Development Goals (SDGs). Areas where progress is more evident refer to SDG 17 “Partnership for the goals”, with all its associated indicators showing an improving performance during the last five years. Relatively similar performances are found for SDG 1 “No poverty” and SDG 13 “Climate action”. Notwithstanding this improving performance, current levels for some of these indicators are significantly lower than the EU average, particularly for SDG 4 “Quality education”, where all indicators are below the EU average, and closely followed by SDG 1 “No poverty” and SDG 3 “Good health and well-being”. Table 1.1:Key economic and financial indicators Source: Eurostat and ECB as of 4-2-2020, where available; European Commission for forecast figures (Winter forecast 2020 for real GDP and HICP, Autumn forecast 2019 otherwise) 2. Progress with country-specific recommendations Since the start of the European Semester in 2011, 47% of all country-specific recommendations addressed to Romania have recorded at least ‘some progress’. 53% of country-specific recommendations recorded 'limited' or 'no progress' (Graph 2.1). Overall, Romania has advanced in implementing its country-specific recommendations since 2013. Even though efforts have been made, in several policy areas, action is slow and the country must endeavour to achieve tangible results on implementing reforms. Graph 2.1:Overall multiannual implementation of 2011-2019 CSRs to date Source: European Commission Since 2016, Romania has been pursuing an expansionary fiscal policy, not respecting its fiscal framework. Such policy led to a significant increase of the public deficit. Since 2016, the authorities have been systematically and repeatedly derogating from the national fiscal rules, thereby rendering them largely inoperable. Limited progress was made to strengthen tax compliance and tax collection. The VAT gap remains the highest in the EU although it is estimated to have decreased since 2017. Risks to fiscal sustainability are high. Due to high public deficit and increasing ageing costs, in particular pensions and health care, the risks to fiscal sustainability are high. These risks worsened in 2019, due to the adoption of the new pension law. On the other hand, several legal provisions that threatened the long term viability of the second pension pillar were abrogated or amended at the beginning of 2020. Substantial progress was achieved in safeguarding financial stability and the banking sector. The bank tax on total assets introduced by the Government Emergency Ordinance 114/2018 was completely removed at the beginning of 2020. Access to quality and inclusive education remains insufficient and skills’ improvement is lacking. Furthermore, consistently low educational outcomes and high rates of early school leaving also remain. Ensuring equal opportunities for students from poor households, particularly in rural areas, and the Roma community remains a challenge. The labour market relevance of vocational, training and higher education remains limited and damages job perspectives. The acquisition of basic and digital skills showed no progress, and would benefit from methods to forecast and anticipate future skill needs. Progress on labour market reforms is limited. Few steps were taken to increase coverage and quality of social services and education, however effective results are not yet visible. The social reference index, used as a basis for most social benefits, has not been updated since its introduction in 2008. Social dialogue remains largely formalistic and modification of the legal framework stalled for a number of years. Even though no objective mechanism is yet in place, the minimum wage increase of January 2020 was based on certain economic indicators such as inflation or labour productivity. The implementation of the minimum inclusion income law, adopted in 2016, continues to be repeatedly postponed, thus no progress was recorded on this front. The healthcare system faces multiple challenges. There has been limited progress in improving access to healthcare. Unmet needs for medical examination reported by patients are increasing again. A sustained policy of incentivising healthcare delivered outside of hospital inpatient settings by the National Insurance House may trigger a natural shift towards ambulatory care. The overall policy measures of the health system to facilitate this shift did not improve. Limited progress was made on focusing investment in key policy areas. Railway infrastructure would benefit from feasibility studies for its upgrade and works are lagging. For road transport, European grants were allocated to develop a multi-standard open-access fast charging network along core-network corridors. Some progress was recorded on the acceleration of the implementation of environmental infrastructure projects, especially in waste water, towards the end of 2019. For other areas, there is either limited progress, for instance waste projects, or no progress, as in regard to air, biodiversity and R&I&D projects. For the latter, without a significant increase in public R&D plus improved regulatory measures to enhance quality, little progress is expected. There has been no progress in improving the predictability of decision-making. Predictability of decision making remains a concern, with no tangible progress. Less than 30% of the annual government plan is respected and the number of emergency ordinances is still very high, with some having major socio-economic impact (e.g. GEO 114/2018). This type of legislation has no mandatory ex-ante impact assessment and no requirement for public consultations. Ex-ante regulatory impact assessment continues to be lacking, with no legal institutional framework. Moreover, although different formal structures exist, the quality of public consultations is deteriorating. Overall, Romania made limited progress () in addressing the 2019 country-specific recommendations. There has been substantial progress on the financial and banking sectors; and some progress on the second-pillar pension-fund viability and public procurement. Limited progress was reached on tax compliance and collection, education, social services and dialogue, healthcare, minimum wage setting, investment and investment prioritisation. No progress was made on the fiscal framework and the public pension system, skills, minimum inclusion income, predictability of decision-making and the corporate governance of state-owned enterprises.

Upon request from a Member State, the Commission can provide tailor-made expertise via the Structural Reform Support Programme to help design and implement growth-enhancing reforms. Since 2017, such support has been provided more than 46 projects. In 2019, several projects were delivered on the ground, including support to the National Fiscal Agency on risk assessment, selection and auditing of large taxpayers and e-commerce transactions and to the Financial Supervisor on developing solutions for dormant accounts on the equity market, as well as consolidating risk based supervision across all sectors. Support was also provided to the National agency for Roma on monitoring and evaluating County Action Plans, to the Ministry of Labour on the development of an indexation mechanism and on piloting a new payment method for social assistance benefits, and to the Ministry of Tourism on the development of destination management organizations. New projects were initiated in late 2019-early 2020 to support the elaboration of the Strategy for Economic and Social Development of the Jiu Valley, the simplification of the licensing system and the adoption of quality management standards for primary care and ambulatory care providers outside hospital settings. Table 2.1:Assessment of 2019 CSR implementation Source: European Commission Box 2.1: EU funds and programmes to address structural challenges and to foster growth and competitiveness in Romania Romania is one of the countries benefiting most from EU support. The financial allocation from the EU Cohesion policy funds ( I ) for Romania amounts to €26.8 billion in the current Multiannual Financial Framework (2014-2020), equivalent to around 2% of the GDP annually. By the end of 2019, some €28.5 billion (more than the total amount planned) was allocated to specific projects and €7.2 billion was reported as spent by the selected projects ( II ), showing a level of implementation well below the EU average. While bringing about a more harmonious development through reducing economic, social and territorial disparities, EU Cohesion policy funding already significantly supports structural challenges in Romania. The Cohesion policy programmes for Romania have allocated EU funding of €2.7 billion for smart growth, €13 billion for sustainable growth and sustainable transport and €6.2 billion for inclusive growth. In 2019, following a performance review ( III ), €888 million have been made available for Romania within performing priorities. EU Cohesion policy funding is contributing to major transformations of the Romanian economy by promoting growth and employment via investments, among others, in research, technological development and innovation, competitiveness of enterprises, sustainable transport, employment and labour mobility. By 2019, investments driven by EU Funds led to the reconstruction of 318 km of TEN-T railway lines, to works on 4,364 km of new or reconstructed roads, out of which 692 km in the TEN-T network and to the reconstruction and modernisation of four airports. Moreover, support is to be provided for 2,708 micro, small and medium size enterprises as well as 178 social enterprises. Cohesion policy funding will contribute to increasing the additional waste recycling capacity by 1,308,262 tonnes/year and to ensure a better conservation status for 41,416 hectares of habitats. In addition, 4,207,040 persons are expected to benefit from flood protection measures. Approximately 350,000 persons benefited from active labour market measures and had access to integrated educational services. Some 6.34 million people received food support and about 15 million food packages were distributed. Agricultural and fisheries funds and other EU programmes also contribute to addressing the investment needs. The European Agricultural Fund for Rural Development makes available €9.6 billion and the European Maritime and Fisheries Fund €223 million (including the national co-financing for both). Romania benefits also from other EU programmes, such as the Connecting Europe Facility, which allocated EU funding of €1.2 billion to specific projects on strategic transport networks, Horizon 2020, which allocated EU funding of €196 million (including 90 SMEs with about €21.2 million) and Erasmus+, which allocated €413 million so far. EU funding contributes to mobilisation of important private investment. European Structural and Investment Funds ( IV ) supported programmes alone mobilise additional capital by committing about €457.8 million via financial instruments in the form of loans, guarantees and equity. EU funds already invest substantial amounts on actions in line with the Sustainable Development Goals (SDGs). In Romania the European Structural and Investment Funds support 13 out the 17 SDGs and up to 95% of the expenditure is contributing to those. 3. Summary of the main findings from the MIP in-depth review The 2020 Alert Mechanism Report concluded that a new in-depth review should be undertaken for Romania to assess the persistence or unwinding of imbalances (European Commission, 2019e). In February 2019, Romania was identified as experiencing macroeconomic imbalances (European Commission, 2019f). The imbalances identified related to risks of cost competitiveness losses and a widening current account deficit in the context of an expansionary fiscal policy and an unpredictable business environment. Moreover, risks to the functioning of the financial sector were also identified. This chapter summarises the analyses in the context of the Macroeconomic Imbalances Procedure (MIP) in-depth review that is contained in various sections of this report (). 3.1.Imbalances and their gravity The current account deficit is large and has been widening since 2014. The current account balance reached a deficit of 4.4% of GDP in 2018 and is estimated to have deteriorated to 5.1% of GDP in 2019. This evolution implies an increasing divergence from the economy's fundamentals, which point to a close- to- balance current account. This is mainly the result of an increasing deficit in the trade in goods, spurred by a fiscal-led consumer spending boom in times of high GDP growth. Changes in composition are also a concern, as growth in imports has been substantially higher for consumer goods than for intermediate or capital goods, meaning that the consumption and import spree is not likely to support the growth potential of the economy or improving living standards in a sustainable way. The coverage of the growing current account deficit by foreign direct investment and the capital account has been declining; instead, portfolio investment has gained relevance. The net international investment position improved further to –43.7% of GDP in 2018, but started to deteriorate in 2019. Past improvements, of more than 20 percentage points since 2012, have been mainly due to the strong nominal GDP growth more than offsetting the current account deficit. Unit labour cost growth remains among the highest in the EU although it started to moderate. Despite significant productivity gains, which are to some extent a catching-up effect from a low starting point, increases in compensation per employee have been significantly outpacing productivity growth since 2016, leading to a marked acceleration of unit labour costs. At the end of 2018, unit labour costs returned to single-digit growth rates, but their increase is nevertheless expected to remain above those of most Member States. The unit labour costs-based real effective exchange rate, which started to increase in 2016, continued to appreciate, albeit at a slower pace. Public and minimum wages have been increasing rapidly, potentially affecting competitiveness. Public wages continued to increase at double-digit rates in 2018 and 2019, although the pace of these increases is expected to diminish as of 2020. Empirical evidence (Biea et al, 2019) shows that the public sector plays a leading role in wage determination in Romania which may lead to higher private sector wages, potentially undermining cost competitiveness. The government-set annual increases in the statutory minimum wage, since 2015, have added to wage pressures and reinforced the potential negative effect on competitiveness. Moreover, non-cost factors such as the quality of infrastructure or the perceived unpredictability of policymaking continue to pose risks to competitiveness. Legislative unpredictability remains a concern. Government Emergency Ordinance 114/2018, adopted with no impact assessment or stakeholder consultation, introduced wide-ranging measures with a negative impact on the financial sector and investments. It was amended by three other emergency ordinances in 2019 and 2020. Although these more recent changes repealed almost entirely the most problematic provisions of the original ordinance of 2018, the quick succession of changes relating to the taxation of banks, energy and telecommunication companies and the functioning of the second pension pillar added to the perception of high legislative unpredictability. 3.2.Evolution, prospects and policy responses The fiscal-driven current account deficit is forecast to remain on a deteriorating path. According to the Commission’s 2019 Autumn Forecast, a further current account deterioration beyond 5% of GDP is expected in 2020 and 2021. At the same time, the fiscal deficit may widen to some 6% of GDP in 2021. The net international investment position may worsen after years of improvements. GDP growth, while still robust, has slowed from its 2017 peak and is expected to decelerate further in 2020 and 2021, while the current account is forecast to continue to deteriorate. This in turn could reverse the substantial improvement in the net international investment position observed since 2012, although the small debt weight may mitigate risks. Overall, recent and prospective developments on the external side expose the economy to growing risks, especially in times of an uncertain world economy or in case of heightened risk aversion. The external financing of the economy is also a concern, with government bond yields among the highest in the region and the sovereign ratings just at investment grade. A number of cost and non-cost factors could hurt competitiveness. Romania’s export market shares continued to increase in 2018 supported by a gradual depreciation of the national currency. However, private sector wages continue to increase strongly due to a very tight labour market, repeated minimum wage increases, and possible spill-overs from strong public sector wage increases, potentially affecting the country’s cost competitiveness. Non-cost factors such as the limited availability of infrastructure, the economy’s low innovative capacity and a cumbersome business environment could also hamper competitiveness in the future. The continued unpredictable policy-making weighs on investment. The uncertainty over policy and legislative decisions has contributed in recent years to the overall perception of unpredictability in the business environment. Public policymaking remained difficult to forecast. In early 2020, 25 Emergency Ordinances were adopted mostly without consultation or impact assessment. The persistent uncertainty about the future direction of reforms could negatively affect firms’ investment and production decisions. 3.3.Overall assessment Romania continues to face risks in the form of an increasing current account deficit and marked cost competitiveness losses. The current account deficit has been widening since 2014, reflecting an expansionary fiscal policy stimulating domestic demand and import growth. Rapidly increasing wages have put unit labour costs under growing pressure as productivity gains, although significant, were not enough to compensate. Wage pressure translated into marked cost competitiveness losses. While export performance still holds, an economic slowdown among some of Romania’s main trading partners could find the country’s current account ill-prepared to accommodate a drop in exports. Policy measures have contributed to the widening current account deficit and risks to cost competitiveness. The fiscal stance has remained highly expansionary, continuing to stimulate consumer spending. The 2020 budget might not ensure sufficient fiscal consolidation. Past decisions on public and minimum wage increases have played a major role in increasing risks to cost competitiveness. While public wages are not expected to increase significantly in 2020 and 2021, a new minimum wage increase of 7.2% was adopted for 2020. The persistence of a large discrepancy between a strong domestic demand, fuelled by an expansionary fiscal policy, and a weakening external demand resulting in a widening current account deficit, further increases the government’s and the economy’s external financing needs. Risks to the financial sector have abated after end 2018 but regulatory uncertainty persists. In January 2020, the government amended the most damaging provisions of government emergency ordinance 114/2018. However, legislative uncertainty affecting the business environment, and in particular the financial sector, appears to persist and requires monitoring.

Table 3.1:MIP assessment matrix (*) - Romania 2020 (Continued on the next page) Table (continued) Source: European Commission 4. Reform priorities 4.1.Public finances and taxation 4.1.1.Fiscal policy (*) () The public deficit has been increasing, due to tax cuts and higher spending on public wages and old-age pensions. (Graph 4.1.1) Tax revenues dropped following cuts in consumption tax rates in 2016-2017 and a lower personal income tax rate as from 2018. On the expenditure side, public wages significantly increased since 2016. At the same time, public investment gradually fell to a post-EU accession low in 2017 and has increased only slightly since then. Therefore, the headline deficit increased from 0.6% of GDP in 2015 to 2.9% of GDP in 2018 and is projected to have risen to 3.6% of GDP in 2019. These policies boosted private consumption but may negatively affect long-term growth. Graph 4.1.1:Drivers of change of general government balance Source: Eurostat, European Commission 2019 Autumn forecast The public deficit is projected to widen further due to significant increases to old-age pensions. Going forward, social expenditures (old-age pensions) are set to increase significantly due to a new pension law adopted in summer 2019 (see Graph 4.1.3 and Box 4.1.1). In particular, the law foresees an ad-hoc indexation of pensions by 40% in September 2020 and a further upward recalculation of pensions in 2021. The law is the main driver of the projected rapid increase of the general government deficit, to 6.1% of GDP in 2021, and of high fiscal sustainability risks (Section 4.1.2). Graph 4.1.2:Gross public pension expenditure in 2018-2022 Source: European Commission (2019c) 4.1.2.Debt sustainability analysis and fiscal risks () Romania’s sovereign risk ratings are at the lower limit of the investment grade and are sensitive to the future direction of fiscal policy. The value of the early-detection indicator of fiscal stress (ʻS0ʼ), which assesses risk within one year, is below its critical threshold. Financial markets’ perceptions of sovereign risk are at the lower limit of the investment grade, with a ‘BBB-’ or equivalent rating of the sovereign debt from the three major rating agencies. However, failure to put in place corrective fiscal measures, offsetting and/or modifying the scheduled significant pension increases, constitutes a key downside risk to Romania's ratings. In fact, on 10 December 2019, S&P Global Ratings revised its outlook on Romania from stable to negative precisely on these grounds. The public debt is set to increase sharply, and the medium-term fiscal sustainability gap to expand, leading to high debt sustainability risks in the medium term. Due to a high structural primary deficit (which is driven by the enacted significant pension increases), and assuming no-policy change, the debt-to-GDP ratio is set on a steep upward path. It is projected to exceed 90% of GDP by 2030 (the end of the projection period). The debt path is sensitive to growth, fiscal and interest rate shocks. The structure of the government debt in terms of maturity longer than 1 year helps to mitigate vulnerabilities. However, the high share of government debt in foreign currency and the substantial debt holdings by non-residents could be aggravating factors, as could the negative net international investment position. Furthermore, the medium-term sustainability gap indicator (‘S1’) shows Romania would require a significant fiscal adjustment in order to achieve the debt target of 60% of GDP in 2034. This indicator nearly quadrupled with respect to last year and is now among the highest in the EU. The high fiscal deficit and increasing ageing costs cause high fiscal sustainability risks over the long term. The relevant indicator (ʻS2ʼ), points to a required fiscal adjustment of 8.8 pps of GDP in order to ensure that the public debt ratio stabilises over the long term. This value, among the highest in the EU, is driven by the initial budgetary position (a contribution of 5.1 pps of GDP) and ageing costs, in particular pensions and health care (a contribution of 3.7 pps of GDP). Both items are driven by the pension law, approved in summer 2019. 4.1.3.Fiscal framework The Fiscal Responsibility Law sets national numerical fiscal rules, which should guide the budgetary process. It contains a structural deficit rule, which requires compliance with or convergence to the medium-term budgetary objective of a structural deficit not exceeding 1% of GDP (). The national framework also contains several auxiliary rules on expenditure and revenue items. Furthermore, the government is required to prepare an update of the fiscal strategy - which sets out the macroeconomic assumptions, medium-term budget planning and expenditure ceilings that should guide the annual budget process - and send it to Parliament by 15 August of the preceding year. Again, the national fiscal framework has not been respected. The fiscal rules laid down in the Fiscal Responsibility Law ‘remained inoperable’ with respect to the 2019 and 2020 budgetary laws, as the authorities continued its practice of derogating from them (Fiscal Council 2019a and 2019d). In particular, the 2019 budget target of a headline deficit of 2.76% of GDP was inconsistent with the structural deficit rule (). Budget amendments adopted in August and November 2019 also derogated from a number of rules, in particular, in the latter case, by increasing the 2019 deficit target to 4.4% of GDP (Fiscal Council, 2019c). Moreover, as in previous years, the government did not send an update of the fiscal strategy to Parliament by the statutory August deadline, sending it in December 2019 instead. This again undermined the guiding role the fiscal strategy should have for the overall budgetary process. The 2020 budget and the fiscal strategy also derogated from several fiscal rules, in particular by targeting a headline deficit of 3.6% of GDP in 2020 (Fiscal Council, 2019d, 2019e and 2020). 4.1.4.Taxation The tax structure is characterised by low levels of revenues, with high reliance on consumption taxes. The tax-to-GDP ratio was 26.3% in 2018, well below the EU average of 39.2%. The tax structure is considered little detrimental to economic growth, as it largely relies on consumption taxes, while the tax burden on labour (including social contributions) is low (European Commission, 2019b). The limited use of recurrent taxes on immovable property and environmental taxes leaves scope to generate revenue in a growth-friendly manner. The impact of the tax system on reducing poverty and income inequality is limited. Income inequality and poverty rates remain among the highest in the EU (see Section 4.3.4). The relatively low level of tax revenues limits Romania's ability to tackle these problems via either redistribution or through the provision of public goods and services (see Section 4.3). The design of labour taxation is among the least progressive in the EU, as measured by the difference between the relative tax burdens for low- and high-income earners (European Commission, 2019b). Such design contributes to the limited impact of the tax and benefit system in terms of reducing income inequality (Graph 4.1.3).

Graph 4.1.3:Redistributive power of the tax and benefit systems in EU Member States, 2017 Source: Commission services calculations based on Eurostat data Environmental taxation remains at a relatively low level. Environmental taxes () amounted to 2.1% of GDP in 2018, below the EU average of 2.4%. Revenues from transport fuel taxes as a share of GDP are among the lowest in the EU. (European Commission, 2019b). The authorities lowered the excise duty on motor fuels from 1 January 2020. This means lower budgetary revenues and a negative impact in terms of the climate objectives. Moreover, the government dropped its plans to introduce a pollutants-dependent car registration tax in 2019. The value added tax (VAT) gap decreased, but remains among the highest in the EU. The VAT gap is the difference between the VAT liability theoretically due and VAT actually collected. It thus represents lost revenue due to evasion, fraud, insolvencies, bankruptcies, administrative errors or legal tax optimisation. The VAT gap is estimated to have marginally dropped from 35.9% in 2016 to 35.5% in 2017 and, according to preliminary estimates, it lowered to 32% in 2018. However, it is still among the highest in the EU (CASE et al., 2019). After repeated delays, there is a progress in the acquisition of electronic cash registers by the taxpayers. Out of an estimated total need of 750,000 cash registers for VAT purposes, approximately 580,000 taxpayers had them in place by December 2019. These registers are not yet connected to the servers of the National Agency for Fiscal Administration (NAFA). The NAFA is planning to develop the IT element of this initiative, i.e. the collection, safekeeping and archiving of the data, to be followed by risk analysis. As of February 1st, 2020, the split VAT mechanism will no longer apply. A split VAT mechanism implies that the taxpayer has a separate, special bank account for cashing in and paying out the VAT. Taxpayers making payments to suppliers using the mechanism are obliged to pay the VAT into the supplier’s special VAT account. The VAT split payment mechanism introduced by Romania in 2018 (mandatory for insolvent or VAT indebted companies) resulted in disproportionate burdens on taxpayers and did not prove efficient in fighting fraud. Starting in 2020, the provisions of the Government Ordinance 23/2017 regarding the split VAT mechanism were repealed, however this needs to be maintained by Parliament. Undeclared work remains high. According to the Romania Fiscal Council, the value of the non-observed economy is 21.5% of GDP. The sectors of high risk are mainly construction, services, and textile manufacturing. According to the NAFA, the compliance seems to have increased in the construction sector following recent tax exemptions (concerning social security contributions and personal income tax) for those working in the sector. However, there is no clear data available. Coordination between the labour inspectorates and the tax authorities is improving. The two institutions sometimes carry joint inspections and have coordinated their risk analysis to a certain extent. In 2019, the two institutions stepped up the number of inspections at various private agencies for labour force/employment placement abroad. NAFA is still in the process of developing specific indicators for use in the risk analysis, including for under-declared earnings. In addition, the Labour Inspection remains relatively under-staffed, with shrinking number of labour inspectors. The tax administration continues its internal reorganisation. NAFA intends to redistribute its human resources to reinforce the Large Taxpayers Office and the local tax administration in Bucharest-Ilfov. It also decided to centralise the risk assessment by creating a single directorate under the direct coordination of its president. The National Centre for Financial Information () is preparing the implement of several IT projects and the introduce SAFT-T files (audit files for tax conforming to OECD standards). A tax amnesty was implemented in summer 2019. Romania does not have a voluntary compliance mechanism giving incentives for reporting and payment of overdue tax obligations. Instead, the authorities tend to enact ad hoc tax amnesties. The tax amnesty enacted in summer 2019 () had two components: tax restructuring and the cancellation of ancillary due amounts (fines and interest). By the beginning of December 2019, approximately 50,000 taxpayers had applied for the tax amnesty, most of them for the cancellation of ancillary obligations. The Fiscal Council (2019c) criticised the measure for the moral hazard it generated, amplified by the fact that only taxpayers who have accumulated a considerable volume of outstanding debt were eligible. In addition, the frequency of tax amnesties raises the problem of optimizing tax obligations over a longer period. The authorities are planning to simplify procedures and reporting obligations to facilitate tax compliance. NAFA intends to introduce some pre-filling for the personal income tax annual declaration as of 2020, with the help of the Private Virtual Space. The authorities are also working on reducing the number of tax returns due from legal persons. Moreover, the authorities are analysing the possibility of extending the scope of electronic filling and submitting of tax returns. Box 4.1.1: New pension law: pension adequacy and budgetary sustainability The pension system in Romania faces challenges connected to low average duration of working lives and to the aging of the population. Romania has one of the shortest average durations of working lives in the EU (33.5 years compared to the EU average of 36.2) and one of the lowest employment rates for older workers. This negatively affects the contributory period and thus the level of pensions. Moreover, projected aging of the population (see Section 1) poses a challenge to pension adequacy and sustainability in the future. The economic old-age dependency ratio, i.e. inactive population aged 65+ as a share of the employed population aged 15-64, is projected to double, from 39.1% in 2016 to 81.5% in 2070. A new pension law, enacted in summer 2019, significantly changed several parameters of the public pension scheme. The pension system in Romania consists of three pillars. The first pillar is a mandatory, pay-as-you-go public point system. The second pillar is a partially mandatory, defined contribution scheme with a guarantee plan, based on individual accounts, while the third pillar is a voluntary, defined contribution scheme based on individual accounts. A new pension law, enacted in summer 2019, contains the following main changes to the first pension pillar: (i) ad hoc indexation of pensions until 2021: by 15% from September 2019 (already included in the 2019 budget law), 40% from September 2020 and 6% from September 2021; (ii) from 2022 onwards, the indexation of the pensions will be 100% of the inflation rate plus 50% of the real average gross wage growth; (iii) starting in 2021, the correction index which used to lift the first pension in line with wages will be abolished; (iv) new pensions will be calculated using at the denominator a fixed contributory period of 25 years, instead of 35 (M) / 31.9 in 2022, going up to 35 as from 2030 (F) years under the previous law; (v) existing pensions will be recalculated upwards to match this new formula. The law also contains some changes to the minimum pension, disability and survivor benefits, while pension, taxation as well as some provisions on pillar II, have also been modified in 2017 and 2018. The new pension law improves pension adequacy, however it has significant budgetary costs in a very short period and causes high fiscal sustainability risks. A third of elderly in Romania were at risk of poverty and social exclusion in 2018, similar rate to the rest of Romanian population but much higher than the EU average (Section 4.3.4). Old-age pensions have been growing below the significant growth of wages of the last years. There are large pension adequacy gaps between different groups of pensioners. The benefit ratio (average public pension as a share of the average wage) amounted to 35.5% in 2016, much lower than the EU average of 43.5%. It is projected to decrease to 31% in 2070 under the new law (European Commission, 2019c), instead of a much lager fall to 26% in 2070 under the previous law. The benefit ratio for the EU as a whole is set to fall to 32.9% over the same period (European Commission, 2018b). Due to its implementation schedule, the law is set to significantly increase public spending on pensions in a short period. It is the main driver of the projected rapid increase of the general government deficit and of high fiscal sustainability risks (Section 4.1.2). Moreover, the law is not accompanied by measures aimed at increasing labour participation and duration of working lives beyond the statutory minimum, which are key to improve both pension adequacy and the sustainability of the pension system. Source: European Commission (2018b and 2019c). 4.2. Financial sector 4.2.1.Banking and insurance developments (*) Despite several headwinds and some signs of asset quality deterioration, the banking sector has remained resilient. The highly criticised bank tax on total assets was recently abolished. Total banking sector capitalisation (19% at the end of June 2019) has been relatively stable for several years and above the EU average. The common equity Tier 1 (CET1) ratio rose to 17.1% in the first half of 2019, up from 18.4% at the same date last year. Even though non-performing loans (NPLs) declined, for unsecured consumer credit in local currency, the system-wide NPL ratio fell further, reaching 5% at the end of June 2019. The stock of legacy impaired assets decreased, albeit at slower pace than in previous years, mainly due to the decline in NPL sales. At the same time, the flow of new NPLs slightly increased. Financial intermediation remains significantly below pre-crisis levels, hampered by a weak corporate sector and various legislative developments. Financial intermediation (measured as the ratio of total private sector credit to GDP) was 25.6% of GDP in 2018, some 11 pps below the 2009 level and roughly three times below the EU average. The main factors behind this low level are several legislative headwinds credit institutions have faced since 2016 and the financial situation of companies (very low or even negative capitalisation) and loose financial discipline, that has constrained their access to credit. Furthermore, the focus on retail lending in the business models of banks, the limited number of bank employees specialising in corporate lending and the low level of financial literacy in Romania have also contributed to the low and declining trend in financial intermediation since 2011. The banking sector’s exposure to the real estate market and government debt is still significant. Supported by the increase in disposable income and government measures, mortgage credit has expanded significantly in the post-crisis period, while consumer lending as a percentage of total lending to households has declined. At the end of March 2019, almost 70% of all loans to households constituted exposure to residential real estate. The mortgage loans granted under the government sponsored First Home (Prima Casa) programme continued to be significant, representing one third of the new housing loans in Q1 2019. However, the intended gradual reduction in the total guaranteed amounts coupled with a lower maximum level of indebtedness eligible in the new programme are expected to create a downward trend in new mortgages granted under this programme. Meanwhile, the attractiveness of mortgage products offered by banks outside the First Home programme is likely to increase. With government bond holdings of almost 18% of total banking sector assets in H1 2019 and a pronounced home bias, the government-bank nexus continues to remain strong. Given the current situation of public finances, (see Section 4.1) the banking sector is exposed to potential negative spill-overs stemming from increases in sovereign spreads and interest rates. Some of the measures applicable to loans to households adopted in early 2019 would have benefitted from an impact assessment. Government Emergency Ordinance 19/2019 introduced the Consumer Credit Reference Index (IRCC), a new benchmark interest rate applicable to new and refinanced mortgage loans (including Prima Casa mortgages) and consumer loans, with variable interest rates. The IRCC is calculated as the arithmetic average of the daily interest rates on effective interbank transactions and is updated quarterly and applied by banks for the next quarter. While the IRCC was introduced with the aim of lowering the cost of credit for households, no proper impact assessment was done to ensure that its calibration and application do not raise concerns regarding an unwarranted adverse impact on the transmission mechanism and conduct of monetary policy (). The Parliament introduced several legislative initiatives, which could have negative impact on the banking sector. Four draft legislative proposals, which build on laws declared unconstitutional in early 2019, were submitted to the Senate in September 2019. The first draft proposal aims to protect consumers against excessive interest rate levels by capping interest rates for household loans (including mortgages). The second proposal intends to shield borrowers from speculative debt-assignment agreements (i.e. sales of bank loans) by declaring the borrower debt-free in the event that the outstanding loan is transferred to a third party. A third proposal concerns the protection of borrowers against abusive or hasty foreclosures. The fourth proposal protects consumers against the foreign exchange risk embedded in credit contracts. Since the first three draft laws would also apply retroactively to outstanding loans, they are likely to induce moral hazard and weaken payment discipline in the banking sector. The proposed amendments to the Statute of the Consumer Protection Authority may increase its competences in the banking sector. A draft legislative proposal already initiated in 2016 appeared to gather new momentum in Parliament in late 2019. It would give the National Consumer Protection Authority (ANPC) the right to supervise the financial and banking sector, by approving and endorsing financial products, to set fees for new financial products proposed by both financial and non-financial institutions, and to impose fines ranging from 0.5% to 10% of revenues at consolidated level (European Commission, 2017b). While enhancing consumer protection is important, some intended amendments to the ANPC Statute might interfere with the mandate of the Romanian Central Bank in the area of banking supervision, particularly in relation to the withdrawal of bank licences. After several years of more benign developments, strain in the insurance sector is re-emerging. Insurance activity in Romania expanded further in 2018, as gross written premiums increased by roughly 4.5% compared to 2017. Insurance penetration (calculated as the share of gross written premiums in a country’s GDP) has remained subdued and well below EU peers. While life insurance is underdeveloped, albeit increasing, the insurance sector is still highly dependent on non-life insurance (in particular compulsory car insurance), which generated 79% of the gross written premiums in 2018. Concentration in the compulsory car insurance business has increased, with two players underwriting the bulk of insurance premiums. The insurance sector has a combined ratio (calculated as losses and expenditures to earned premiums) for all business lines, which increased to 110% at the end of June 2019, while it stood at roughly 103% in 2018 and 98% in 2017. The combined ratio reached 122% for compulsory car at the end of June 2019, due to the increase in distribution costs, the higher costs charged by auto services companies and more accidents and casualties.

4.2.2.Pensions - Second pension pillar The headwinds faced by the second pillar pension funds have subsided, but pockets of vulnerability remain. In January 2020, the government abolished several provisions targeting the second pillar pension funds, which were introduced by the former government in December 2018 and May 2019. The minimum capital requirements for pension fund management companies were restored to the level before the adoption of the Government Emergency Ordinance 114/2018. The provision whereby participants in the second pillar could switch to the Pay-As-You-Go pillar, after five years of contributing to the second pillar, was removed. The administration fees levied on gross contributions by the pension fund management companies, which were significantly cut in December 2018, were further modified in early 2020, but without prior in-depth analysis consulted with all relevant stakeholders. The reduction in administration fees has had a negative impact on the results of pension funds management companies. Due to lower administration fees the revenues of pension funds management companies declined significantly in the first ten months of 2019. Thus, after seven successive profitable years, the sector registered an aggregate negative result as of October 2019. Since the industry is in its early years in Romania, detecting any unwarranted adverse effects on the performance and prudential situation of these pension fund management companies from the reduction in administration fees could be useful to allow for potential further fine-tuning and a sustainable second pillar for retirement. 4.2.3.Capital markets and access to finance Non-bank financing in Romania has continued to lag significantly behind bank credit to firms. Bank loans are the most important external financing source for firms in Romania, amounting to about 11.7% of GDP in 2018 (EU average of about 34% of GDP). Market based financing was with 6.2% of GDP also significantly below the EU average of 49.7% of GDP in 2018(). According to surveys by the National Bank of Romania, companies resort primarily to internal financing sources for their operational activity and investment projects. Firms’ recourse to bank loans is relatively low, the main sources of external financing being overdrafts and credit lines. Companies using external financing face higher financing costs and loan application rejection rates, in particular due to low financial soundness () (NBR, 2019b). The microfinance sector has become the fifth most active microfinance sector in the EU, having good growth potential (OECD, 2018a). Access to risk capital for innovative start-ups and scale-ups remains limited. Romanian firms operating in high tech knowledge-intensive services and manufacturing tend to be more finance constrained than firms active in less knowledge intensive sectors are (EIB, 2019a). This could be due to a lack of appropriate supply and financing instruments adapted to the needs of innovative start-ups and scale-ups. Romania was among the most attractive destinations in Central and Eastern Europe for private equity and venture capital funds (Invest Europe, 2018a) and venture capital investments have increased over the last four years. However, the size of the market and volumes are still relatively low and concentrated in few sectors, primarily in the Bucharest and Vest regions (Flachenecker et al., forthcoming). Efforts to support business creation with various financing options are initiated by national authorities, but lack a targeted approach and funds (OECD 2018b). Various initiatives could support capital market development. With the support of the Financial Supervisory Commission (ASF), the process of setting up a central counterparty clearinghouse (CCP) in Romania has progressed further, which could contribute to the increase in derivative trading once operational in 2020. The ASF also aims to prepare a capital market strategy with the support of the Commission’s Structural Reform Support Programme and is counting on the pro-active involvement of the government to ensure its success. After Romania's upgrade to Secondary Emerging market status by Financial Times Stock Exchange (FTSE) Russell and the inclusion in the CEEplus Index, these initiatives could further help boost the Romanian capital market and companies’ access to non-bank financing. This should be complemented by several initiatives and a national strategy for financial literacy following a memorandum signed in 2018. 4.3. Labour market, education and social policies 4.3.1.Labour Market Positive labour market developments in Romania continue on the back of sustained economic growth but labour shortages persist. The labour market dynamics remain positive, with the employment at a record level of 70.8% in Q3-2019 (), and the unemployment rate falling to 3.9%. However, differences in labour market outcomes remain between regions and population groups. On the back of the positive economic developments, labour market conditions remain tight, with labour and skills shortages. These are exacerbated by the decline in the labour force (). Demographic change and migration have a strong impact on labour market dynamics. The population continues to decrease due to a negative natural rate of population growth and outward migration. In 2018 Romanians were the largest group of EU citizens of working age (20-64) residing in other Member State (2,524,000 persons) (). The emigration of working age Romanians increased by 7% compared to 2017, calling for continuous efforts to upskill and re-skill the labour force remaining in the country. Graph 4.3.1:Demographic growth and working age population Source: European Commission Despite a slight improvement, inactivity remains high, with significant differences between age groups and across regions. The inactivity rate amounts to 31.6% (Q3 2019) of the overall population. Persistent high levels of inactivity are registered for women, young people aged 15-24 (71.17%), older people aged 55-64 (50.8%) and women aged 15-64 (41.7%) in Q3 2019. The inactivity gap between low- and high skilled youth remains high (43.3 pps). In the age group 20-64, family and caring responsibilities are often the main reasons for not seeking employment (23.6% of the inactive population). There are also regional disparities in inactivity rates (2018) between Centru (38.4%), Sud-Est (36.9%), and Vest (38%), compared to Nord-Est (26.3%) and the capital region (26%). Active labour market policies, mainly employment subsidies, have little impact on reducing inactivity. In 2019, the number of apprenticeship contracts taken-up increased to more than 6,150 from around 430 contracts in 2017, as subsidies to employers were doubled in 2018 (from RON 1,125 to RON 2,250). In addition, subsidies for employing people from disadvantaged groups also increased. However, the share of employed persons in the total of participants in active measures was only around 40%, 6 months after participating in the measure. There remains significant scope to improve the effectiveness of activation measures, in particular for providing tailor-made services to vulnerable groups, such as low-skilled, old workers and persons with disabilities. While the employment rate for people with disabilities is below the EU average, 43.7% vs 50.6%, the legal framework does not effectively incentivise their employability and public employment support services are limited. Necessary reforms in the case management approach and relations with employers continue to stall, despite the European Social Fund funding (ESF) available. Access to the labour market remains limited for certain groups. In 2018, the share of long-term unemployment within total unemployment increased to 44.1%, after declining from 50% in 2016 to 41.4% in 2017. Around 100,000 long-term unemployed are currently registered with the public employment services. Eighty eight per cent of them come from rural areas, around 9% are Roma and more than 90% are identified as having a low level of employability. Skills mismatches and lack of basic skills are obstacles to tackling these issues. Public employment services are not effectively tailored to individual needs and lack integration with social services, despite substantial funding being available. The percentage of young people neither in education nor in employment and training is among the highest in the EU. In 2018, 14.5% of young people (15-29 years) were neither in education nor in employment and training (NEET), compared to the EU average of 14.5%. More than a third of them were discouraged workers, short- and long-term unemployed (). Despite the positive outcomes of some outreach measures, around 69% of NEETs remain inactive. In addition, a very high and increasing share of young people leave the country. The gender gap in activity and employment remains high. At 19 pps in Q3 2019, the gender gap in activity increased further to above the EU average (10.7 pps). In 2018, the share of active women (15-64 years) was 58.7% (EU average 68.7%), compared to 7.9% for men (EU average 79.4%). The lowest activity rates were recorded among younger (aged 15-24) and older women (aged 55-64). Approximately 12% of women were inactive due to personal and family responsibilities. In 2018, the gender employment gap of people having one child below the age of six was as high as 29 pps. High early school leaving rates and insufficient childcare facilities and services negatively affect female labour market participation especially in rural areas (see Section 4.3.2). In a context of increasing demand for labour and falling unemployment, labour shortages persist in some sectors. In the first three quarters of 2019, companies in the services sector (9.8%), construction (25.1%) and industry (13.7%) reported labour shortages as a factor hindering production (European Commission, 2019f), an increase compared to 2018. Future labour demand is expected to shift with a need for particular skills in some sectors and occupations (Cedefop, 2019). In 2018, job vacancies were reported mostly in the manufacturing sector (27%), followed by health and social work activities (11%), and public administration (13%) (). By 2030, an increase in the demand for labour is expected for professional services, sales workers and associate professionals, while the demand for trade and agriculture workers is expected to decrease. The skills mismatch has persisted over the recent years. The European Skills Index measuring the performance of EU skills systems shows that Romania is among the worst performers, especially in skills development and activation (Cedefop, 2019). In addition, the occurrence of vertical mismatches (over-qualification rate), while still below the EU average, almost doubled over the last decade. Thus, in 2018, 18% of workers with tertiary qualifications were employed in occupations that did not require that level of qualification while 28% of the employed people aged 25-34 with tertiary education were occupying a job that required tertiary education but their education or skills did not match the requirements of the job (Eurostat, Mismatch indicators). It points to a widening gap between education and work. Technological changes are expected to generate a shift in demand towards higher skills and qualifications, which might not be fully met by current labour supply, given the time necessary for the education and training system to adjust. Graph 4.3.2:Developments in hiring Source: European Commission, Labour Force Survey

The need for upskilling is high. In 2018, nearly 2.3 million people (21.5% of adults) only had low educational attainment. In 2018, only 0.9% of adults aged 25-64 had a recent learning experience (EU average 11.1%). This is particularly concerning given the low number of available jobs requiring only a basic level of education. Recent attempts have been made to address the issue of upskilling and re-skilling. A new regulation for quality assurance in adult learning is also under development. Wages in Romania continued to grow rapidly. In 2018, the nominal compensation per employee increased by 16.3%, also due to the rapid increases in public sector wages and rises in the minimum wage. In Q1-2019, wages still posted double-digit growth. Compensation per employee is expected to continue growing although at a gradually slower pace (13% in 2019 and 9% in 2020), following the expected slowdown in public wages. Real wages grew faster than productivity, increasing the share of national income that went to labour, as was also the case in a number of other Eastern European Member States with comparatively low labour shares in the past (), contributing to further wages convergence in the EU. There is still no objective mechanism to determine the minimum wage in Romania. The minimum wage increased from RON 975 (€210) to RON 2,080 (€442) between 2015 and 2019 and was raised further to RON 2,230 (€496) in January 2020. According to the authorities, this latest increase was based on a formula taking into account several economic indicators, such as the inflation rate and labour productivity. The decision was preceded by discussions with the trade unions and employers' organizations. However, an objective mechanism to determine the minimum wage is not yet in place. While being among the lowest in the EU, the gross minimum wage in Romania currently amounts to 43% of the average wage and 58% of the median wage. Approximately 20% of people under a full time contract receive the minimum wage, resulting in a highly compressed wage distribution. This indicates a high incidence of envelope wages that come as a complement (see Section 4.1). Social partners are not sufficiently engaged in reforms addressing labour market challenges and other relevant policy issues. The established institutional framework for social partners’ consultation is not adequately used to feed into the decision-making process. The limited capacity building of social partners and ineffective dialogue remain a concern. Social partners still do not enter into voluntary dialogue in order to address labour market challenges and their involvement and contribution in policymaking remains limited. The government plans to review the role of social dialogue committees in order to improve the involvement of social partners. Discussions on changes to the social dialogue law and the revision of economic sectors have stalled. The draft changes to the law have been in parliamentary procedure since June 2018. In April 2018, the International Labour Organisation gave recommendations on the legislative project but the follow-up is uncertain. The delineation of sectors still does not allow for sufficient representation of workers or employers in most sectors, and there are no immediate plans for improvement (). The authorities report higher rates of collective bargaining coverage 45%, which may be linked to collective bargaining becoming temporarily mandatory for all employers, following the shift in social security contributions from employers to employees at the end of 2017. 4.3.2.Education and Skills Underfunding and delayed reforms continue to hamper the equity, inclusiveness and quality of education. Spending on education remains one of the lowest in the EU (2.8% of GDP vs 4.6% EU average), particularly at pre-primary and primary level, which account for just 21.8% of the budget (EU average 32%). Persistent problems with the acquisition of basic skills at school () and the low digital literacy of the population () pose challenges for the labour market integration of future graduates. The enrolment rates at all education levels remain significantly below the EU average. Despite recent improvement, early school leaving is still very high, with negative effects for labour market participation, poverty and social inclusion. Ideas for important reforms of the educational system have been put forward by both the Ministry of Education and the Presidential Administration but have not yet been pursued. Delays in the rationalisation and modernisation of the school infrastructure may affect the quality of education. The school-age population is projected to fall by 10% by 2030. Between 2000 and 2016, Romania closed 25% of its schools and 17% of the satellite schools (World Bank, 2018). Yet, 58% of schools still have a surplus of building space, while 22% of students study in overcrowded schools, mostly in urban areas (MEN, 2018). In addition, equity challenges are not effectively addressed, with long walking distances to schools and kindergartens in rural areas and commuting costs posing barriers to access. A strategy for rationalising the school infrastructure was developed by the Ministry of Education but not yet adopted. Low participation in early childhood education and care widens inequality of opportunities between pupils. Only 15.7% of children below the age of three are in formal childcare. For children aged between four and the compulsory school age participation increased to 89.6% in 2017, but remains below the EU average (95.4%). This rate is even lower for children in rural areas () and Roma (). This has a detrimental effect on the acquisition of basic skills and on the social mobility of children from disadvantaged backgrounds or marginalised communities. The coverage of the kindergarten network improved but rural-urban disparities persist. Some steps are being taken to increase access and quality of services, including with EU structural funds support. Despite recent improvements, early school leaving remains very high, deepening existing socio-economic disparities. The rate of early school leavers from education and training stood at 16.4% in 2018, almost 6 pps above the EU average. This rate is particularly high in rural areas (around 25%) (), for Roma () and children with disabilities (). Regional disparities persist, with the highest rates of early leavers being recorded in the South-East and North-East regions, which also face the highest poverty levels. The high rate of early leavers from education and training in some regions correlates with low degrees of urbanisation (e.g. North-East). Romania also has the highest rate of early school leavers for girls in the EU (16.1% vs. 8.9% EU average), posing challenges in terms of the likely future persistence of the already high employment gender gap. Comprehensive measures targeting early school leaving through tailor-made support for vulnerable pupils are not yet in place. Such measures would contribute to progressing toward SDGs 4, 5 and 10. The education system continues to face significant challenges in terms of quality and inclusiveness. Romania is one of the countries with the highest share of low achievers among 15-year olds in all three areas tested under the OECD Programme for International Student Assessment (PISA) (), and results have worsened since 2015. The mean score of pupils in all three domains is over 60 points below the EU average, the equivalent of one-and-a-half years of schooling. Persistent lower attainment levels are reported in rural and economically deprived areas (), including those with a high Roma population. In general, poorer students are more likely to receive a lower quality education (World Bank, 2018). Similarly, only 4% of new university entrants have parents with low educational attainment (European Commission, 2018c). In 2016, the Ministry of Education issued a document banning school segregation, but adopted the methodology only in 2020, and the implementation of planned actions has been delayed. Such measures, if implemented, would contribute to progressing toward SDG 10. The low labour market relevance of vocational education and training negatively affects graduates’ job prospects. In 2018, the employment rate of vocational education and training (VET) graduates increased slightly to 69 % from 67.2% in 2017, but remains well below the EU average (79.5%). Students enrolled in VET programmes had limited exposure to work-based learning, with only 10% enrolled in d