Council opinion of 27 March 2007 on the convergence programme of Romania, 2006-2009
Date: 2007-03-27
Institutions: Council of the European Union
Subjects: Romania, budget estimate, economic convergence, economic forecasting, public finance, stability programme

24.4.2007

EN

Official Journal of the European Union

C 89/19

COUNCIL OPINION

of 27 March 2007

on the convergence programme of Romania, 2006-2009

(2007/C 89/06)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveil-
lance of budgetary positions and the surveillance and coordination of economic policies (1), and in particular
Article 9(1) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1)

(2)

(3)

(4)

(5)

On 27 March 2007 the Council examined the convergence programme of Romania, which covers
the period 2006 to 2009.

Romania enjoyed strong economic growth over the past five years, but its GDP per capita (expressed
in PPS) is still low at 34 % of the EU-25 average in 2005. Therefore, the scope for catching up
remains ample and represents Romania's overriding challenge for the medium and long term. In
2001-2005 macroeconomic stability improved, as reflected by the sharp and sustained decline in
inflation and the consolidation of public finances. The average inflation rate stood at 6,6 % in 2006.

The macroeconomic scenario underlying the programme envisages that real GDP growth will decele-
rate progressively from a well-above potential rate of 8 % in 2006 to a still sustained 5,9 % in 2009.
Assessed against currently available information, this scenario appears to be based on plausible
growth assumptions. The programme's projections for inflation appear to be on the low side since
they assume a sustained deceleration of credit and private consumption growth which may not mate-
rialise. Unlike the programme, the Commission's services 2006 autumn forecast projects a further
widening of the external deficit in 2007 and 2008 on the basis of imports that continue to outpace
exports as a result of strong private consumption and investment.

For 2006,
in the Commission services' autumn 2006 forecast estimated the general government
deficit at 1,4 % of GDP against a target of 0,7 % of GDP set in the December 2005 pre-accession
economic programme. The convergence programme estimates the deficit at 2,3 % of GDP. The slip-
page compared to the original target reflects significant additional expenditure, notably current
spending partly due to a reallocation of unspent investment expenditures, which more than offset
stronger revenue growth than expected.

The main goal of the programme is to pursue fiscal consolidation so as to reach the medium-term
objective of a structural deficit (in cyclically-adjusted terms net of one-off and other temporary
measures) of 0,9 % of GDP in 2011, i.e. beyond the programme period. The programme targets a
small reduction of the general government deficit from 2,3 % of GDP in 2006 to 2 % of GDP in
2009, after a rise to 2,7 % of GDP in 2007. The primary deficit is expected to follow a similar path
and to stand at 1 % of GDP at the end of the programme period.

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The

documents referred to in this text can be found at the following website:
http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm

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Official Journal of the European Union

24.4.2007

(6)

(7)

(8)

(9)

The adjustment, which is marginal and back-loaded is done through an increase in the revenue-to-
GDP ratio that is somewhat higher than the increase in the expenditure-to-GDP ratio (almost 4
percentage points compared to 3½ percentage points). On the revenue side, most of the increase
comes from taxes (especially in 2007) and from ‘other revenues’ (presumably associated with EU
funds inflows). The rise in the expenditure ratio stems to a large extent from a very significant
increase in public investment, which is planned to more than double as a percentage of GDP due to
an assumed substantial increase in the absorption of EU funds. Compared with the December 2005
pre-accession economic programme, budgetary targets are far less ambitious although the underlying
growth assumptions are similar.

The structural deficit (i.e. the cyclically-adjusted deficit net of one-off and other temporary measures)
calculated according to the commonly agreed methodology is planned to deteriorate further from
3 % of GDP in 2006 to around 3½ % of GDP in 2007 before improving to 2¼ % of GDP in 2009.
As mentioned above, the medium-term objective (MTO) for the budgetary position presented in the
programme is a structural deficit of 0,9 % of GDP, which the programme aims to achieve by 2011, i.
e. beyond the programme period. As the MTO is more demanding than the minimum benchmark
(estimated at a deficit of 1¾ % of GDP), achieving it should fulfil the aim of providing a safety
margin against the occurrence of an excessive deficit. The MTO adequately reflects the debt ratio and
average potential output growth in the long term.

The risks to the budgetary projections in the programme appear broadly balanced in 2007, but
budgetary outcomes could be worse than projected in the programme thereafter. In 2007, both
expenditure and revenues might be lower than planned: the former because public investment plans
are unlikely to be achieved and the latter because the assumed tax intensity of economic activity
appears to be favourable, explained to a certain extent by the recently implemented measures in the
area of tax administration reform. From 2008 onwards, the budgetary strategy is insufficiently speci-
fied, with a volatile path for several expenditure items and an unsubstantiated tightening in 2009.
Expenditure slippage in recent years through frequent budgetary amendments,
the uncertainty
regarding the total amount of compensation to be paid by general government to citizens for the
non-return of properties nationalised during the communist regime and potential cancellations of
public enterprises' unpaid liabilities towards general government point to a risk of expenditure over-
runs, even though the level of planned spending on investment will likely be undershot. In addition,
over-budgeted resources allocated to investments might be shifted to consumption as seen in the
past, with a negative impact on the quality of public spending.

In view of this risk assessment, the budgetary stance in the programme seems insufficient to ensure
that the MTO is achieved within the programme period, as also envisaged in the programme. In addi-
tion, it does not seem to provide a sufficient safety margin against breaching the 3 % of GDP deficit
threshold with normal macroeconomic fluctuations throughout the programme period. The pace of
the adjustment towards the MTO implied by the programme is insufficient and should be strength-
ened significantly to be in line with the Stability and Growth Pact, which specifies that the adjustment
should be higher in good economic times and could be lower in bad economic times. In particular,
in a context of good times, the structural improvement is marginal and fully back-loaded, with a dete-
rioration in 2007, while the planned adjustment, notably in 2009 is not supported by measures.

(10) Government gross debt is estimated to have reached around 13 % of GDP in 2006, well below the
60 % of GDP Treaty reference value. The programme projects the debt ratio to decline by around 1
percentage point of GDP over the programme period.

(11)

In the absence of the long-term projections of age-related expenditures, based on the common
macroeconomic assumptions as carried out by the EPC/Commission, it is not possible to assess the
impact of population ageing in Romania on a comparable and robust basis as it is currently done for
the other Member States, for which the projections on this basis are available. However, a significant
impact of ageing on expenditure cannot be excluded given the current demographic structure. The
initial budgetary position, with a large structural deficit, is not sufficient to stabilise debt even before
considering the long-term budgetary impact of ageing. Improving the structural budgetary position
over the medium term would contribute to containing risks to the sustainability of public finances.

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Official Journal of the European Union

C 89/21

(12)

The budgetary strategy in the programme is partly consistent with the broad economic policy guide-
lines included in the integrated guidelines for the period 2005-2008. In particular, the budgetary
adjustment
towards the MTO is insufficient and should be strengthened significantly over the
programme period. Moreover, the fiscal strategy put forward in the programme, notably the loos-
ening of the fiscal stance until 2007, and the limited consolidation thereafter add to aggregate
including those regarding the need to maintain sustained high
demand management concerns,
growth, to continue to support the disinflation process and to contain the increase in the external
deficit, which is estimated to have reached 10,3 % of GDP in 2006.

(13) As regards the data requirements specified in the code of conduct for stability and convergence

programmes, the programme has some gaps in the required and optional data (1).

The Council considers that, in a context of strong growth prospects and a widening external deficit, the
programme envisages a pro-cyclical loosening in 2007. Progress towards the MTO is insufficient and back-
loaded, starting only in 2009, and is targeted to be reached only beyond the programme period. Moreover,
there are risks to the achievement of the budgetary targets from 2008 onwards. In view of the above assess-
ment, the Council invites Romania to:

(i) exploit the good times to significantly strengthen the pace of adjustment towards the MTO by aiming
for more demanding budgetary targets in 2007 and subsequent years.
Improving the structural
budgetary position over the medium-term would contribute to containing risks to the sustainability of
public finances;

(ii) control the envisaged high increase in public spending and review its composition so as to enhance the
growth potential, as well as improve the planning and execution of public expenditures within a binding
medium-term framework.

Comparison of key macroeconomic and budgetary projections (1)

Real GDP
(% change)

HICP inflation
(%)

CP Jan 2007

COM Nov 2006

PEP Dec 2005

CP Jan 2007

COM Nov 2006

PEP Dec 2005

Output gap
(% of potential GDP)

CP Jan 2007 (2)

COM Nov 2006 (6)

PEP Dec 2005

2005

2006

2007

2008

2009

4,1

4,1

5,7

9,1

9,1

9,0

0,2

0,4

n.a.

8,0

7,2

6,0

6,6

6,8

7,0

2,1

1,9

n.a.

6,5

5,8

6,3

4,5

5,1

5,0

2,2

1,5

n.a.

6,3

5,6

6,5

4,3

4,6

3,6

1,9

1,0

n.a.

5,9

n.a.

n.a.

3,2

n.a.

n.a.

1,1

n.a.

n.a.

General government
balance
(% of GDP)

CP Jan 2007

– 1,5

– 2,3

– 2,7

– 2,6

– 2,0

COM Nov 2006

– 1,5

– 1,4

– 2,6

– 2,6

PEP Dec 2005

– 0,4

– 0,7

– 1,0

– 1,6

n.a.

n.a.

(1) In particular the data on the subcomponents of the stock-flow adjustment and the contributions to potential GDP growth

by labour, capital and TFP are missing.

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Official Journal of the European Union

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Primary balance
(% of GDP)

Cyclically-adjusted
balance
(% of GDP)

Structural balance (3)
(% of GDP)

Government gross debt
(% of GDP)

CP Jan 2007

COM Nov 2006

PEP Dec 2005

CP Jan 2007 (2)

COM Nov 2006

PEP Dec 2005

CP Jan 2007 (4)

COM Nov 2006 (5)

PEP Dec 2005

CP Jan 2007

COM Nov 2006

PEP Dec 2005

2005

2006

2007

2008

2009

– 0,4

– 0,3

0,8

– 1,5

– 1,6

n.a.

– 1,5

– 1,6

n.a.

15,9

15,9

17,1

– 1,2

– 0,4

0,4

– 3,0

– 2,0

n.a.

– 3,0

– 2,0

n.a.

12,8

13,7

15,1

– 1,6

– 1,7

0,0

– 3,4

– 3,1

n.a.

– 3,4

– 3,1

n.a.

13,5

13,9

14,6

– 1,5

– 1,7

– 0,6

– 3,2

– 2,9

n.a.

– 3,2

– 2,9

n.a.

12,6

14,4

14,6

– 1,0

n.a.

n.a.

– 2,3

n.a.

n.a.

– 2,3

n.a.

n.a.

11,7

n.a.

n.a.

Notes:
(1) The government accounts of Romania have not yet been officially subject to a complete quality assessment by Eurostat. Eurostat will

publish and validate government balance and debt figures shortly after the data notification of 1 April 2007.

(2) Commission services calculations on the basis of the information in the programme.
(3) Cyclically-adjusted balance (as in the previous rows) excluding one-off and other temporary measures.
(4) There are no one-off and other temporary measures in the programme.
(5) There are no one-off and other temporary measures in the Commission services' autumn 2006 forecast.
(6) Based on estimated potential growth of 5,6 %, 5,7 %, 6,1 % and 6,2 % respectively in the period 2005-2008.

Source:
Convergence programme(CP); Pre-accession economic programme (PEP); Commission services' autumn 2006 economic forecasts (COM); Commission
services' calculations