COMMISSION STAFF WORKING DOCUMENT Accompanying the document Recommendation for a COUNCIL RECOMMENDATION with a view to correcting the significant observed deviation from the adjustment path toward the medium-term budgetary objective in Romania
Date: 2017-05-22
Institutions: Directorate-General for Economic and Financial Affairs, European Commission
Subjects: Romania, budget deficit, economic policy, economic reform, financial control, gross domestic product, job creation, multilateral surveillance, price stability, stability programme

EN 

   EN 

   EUROPEAN COMMISSION  Brussels, 22.5.2017  SWD(2017) 174 final   COMMISSION STAFF WORKING DOCUMENT Accompanying the document Recommendation for a  COUNCIL RECOMMENDATION with a view to correcting the significant observed deviation from the adjustment path toward the medium-term budgetary objective   in Romania {COM(2017) 268 final}  
 
 
COMMISSION STAFF WORKING DOCUMENT 

Accompanying the document 

Recommendation for a 

COUNCIL RECOMMENDATION 

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

in Romania 

1. 

INTRODUCTION 

The Council abrogated its decision on the existence of an excessive deficit in Romania on 21 
June 2013, on account of the correction of Romania's excessive deficit in 2012, which, based 
on the Commission 2013 spring forecast, appeared durable.  

Since then Romania has been subject to the preventive arm of the Stability and Growth Pact, 
which  requires  sufficient  progress  towards  the  medium-term  budgetary  objective  (MTO). 
Romania is not subject to the debt rule as its general government debt remains below 60% of 
GDP.  

On 12 July 2016, the Council addressed recommendations to Romania in the context of the 
European  Semester1.  In  particular,  in  the  area  of  public  finances  the  Council  recommended 
Romania to limit the deviation from the MTO in 2016 and achieve an annual fiscal adjustment 
of 0.5% of GDP in 2017 unless the MTO is respected with a lower effort. 

Based  on  the  Commission  2017  spring  forecast,  Section  2  of  this  document  presents 
macroeconomic  and  fiscal  developments  in  2016-17.  Section  3  presents  an  assessment  of 
compliance with the obligations stemming from the Stability and Growth Pact, including an 
overall  assessment  of  the  reasons  for  the  deviation  from  the  requirements  of  the  preventive 
arm. Section 4 proposes a fiscal effort for 2017 to address the significant deviation, including 
a  new  applicable  expenditure  benchmark  rate  compatible  with  the  suggested  annual 
improvement in the structural balance. Section 5 provides the overall conclusions.  

2. 

MACROECONOMIC AND FISCAL DEVELOPMENTS IN 2016 

In 2016, real GDP growth rose to an eight-year high of 4.8%, driven mainly by consumption, 
which  was  boosted  by  expansionary  fiscal  policy  and  wage  hikes.  Investment,  by  contrast, 
contracted as public investment fell following a slow uptake of new projects financed by EU 
funds in the 2014-2020 programming period. The contribution of net exports to growth was 
negative, as imports outpaced exports on the back of strong consumption growth. 

An  additional,  sizeable  although  smaller  fiscal  stimulus  planned  in  2017  is  projected  to 
continue to support domestic demand and growth, but at a slower pace as the transitory effects 
of  the  fiscal  impulse  of  2016  wear  out.  Growth  is  expected  to  remain  consumption-driven, 
boosted  by  tax  cuts  and  increases  in  public  wages  and  pensions.  Investment  is  forecast  to 
make  a  modest  contribution  to  growth  as  the  implementation  of  projects  financed  from  EU 
funds gradually picks up. 

The  labour  market  continued  to  improve  in  2016  on  the  back  of  strong  real  GDP  growth. 
Unemployment  dropped  to  a  historical  low  in  2016.  Low  unemployment,  combined  with  a 

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OJ C 299, 18.8.2016, p. 73. 

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shrinking  labour  force  and  persistent  skills  shortages,  led  to  a  tighter  labour  market  and 
economy-wide  wage  increases.  Total  employment  decreased  in  2016  as  the  decline  in  self-
employment more than offset the increasing number of employees. Total employment is set to 
increase  at  a  moderate  pace  in  2017  and  2018  due  to  high  inactivity  rates  and  negative 
demographics, driven by strong growth, while the unemployment rate is projected to continue 
to  decline.  The  growth  of  compensation  per  employee  accelerated  in  2016,  on  the  back  of 
increases in the minimum wage and public sector wages. 

The  main  risk  to  the  outlook  is  the  possibility  of  a  further  fiscal  stimulus  in  line  with  the 
government  programme,  which  may  boost  domestic  demand  in  the  short-run,  but  at  the 
expense  of  posing  additional  risk  to  the  sustainability  of  public  finances.  In  the  absence  of 
structural reforms to support competiveness, potential growth would be constrained. 

Table 1. Macroeconomic developments and forecast 

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2015201620172015OutturnCP 2016OutturnCP 2016CP 2017COMReal GDP (% change)3.94.24.84.35.24.3Private consumption (% change)6.06.37.45.37.36.9Gross fixed capital formation (% change)8.36.6-3.36.96.91.3Exports of goods and services (% change)5.44.58.35.66.86.9Imports of goods and services (% change)9.28.79.87.88.58.6Contributions to real GDP growth:- Final domestic demand5.76.04.45.36.35.1- Change in inventories-0.20.01.10.0-0.30.0- Net exports-1.6-1.8-0.7-1.0-0.8-0.8Output gap1-1.3-0.4-0.10.0-0.10.7Employment (% change)-0.90.2-0.90.60.70.1Unemployment rate (%)6.86.75.96.65.75.4Labour productivity (% change)4.94.05.83.74.44.2HICP inflation (%)-0.4-0.5-1.12.31.21.1GDP deflator (% change)2.42.02.22.12.01.5Comp. of employees (per head, % change)0.95.610.35.25.89.5Net lending/borrowing vis-à-vis the rest of the world (% of GDP)1.80.7-1.50.50.4-1.31In % of potential GDP, with potential GDP growth recalculated by Commission services on the basis of the programme scenario using the commonly agreed methodology.Source:Commission 2017 spring forecast (COM); Convergence Programme (CP).Note:20162017 
 
 
 
 
 
In 2016, the general government deficit rose to 3% of GDP, from 0.8% of GDP in 2015, while 
the economy grew above its potential. Tax cuts, particularly a four percentage point cut in the 
standard  VAT  rate,  had  a  negative  effect  on  tax  revenues.  On  the  expenditure  side,  public 
wages  were  considerably  increased.  The  2016  budget  outcome  was  slightly  worse  than  the 
2016 Convergence Programme target of a deficit of 2.9% of GDP. Both the revenues and the 
expenditures  turned  out  lower  than  planned  in  the  2016  Convergence  Programme.  On  the 
revenue  side,  the  indirect  tax  revenues  target  was  not  achieved.  On  the  expenditure  side, 
public investment was significantly lower than planned. 

The  Commission  2017  spring  forecast  projects  the  headline  deficit  to  increase  to  3.5%  of 
GDP  in  2017.  The  standard  VAT  rate  was  cut  by  an  additional  one  percentage  point. 
Moreover, part of the excise duty on fuel and a special construction tax were abolished. The 
2017 budget contains significant increases of public wages and social benefits, including an 
additional pension increase of 9%, scheduled for July 2017, on top of the standard indexation. 

The  Romanian  authorities  in  the  2017  Convergence  Programme  plan  a  headline  deficit  of 
2.9%  of  GDP  in  2017.  The  overall  revenues  and  expenditures  ratios  are  higher  than  in  the 
Commission forecast. The underlying macroeconomic projection of 5.2% of real GDP growth 
is  more  optimistic  than  the  Commission  projection,  with  a  positive  impact  on  tax  revenues. 
The projection of revenues from all categories of taxes and social contributions is higher than 
in the Commission forecast (see Table 2). On the expenditure side, public wages and social 
contributions are lower than in the Commission forecast, while planned public investment is 
significantly higher. The lower public investment projection in the Commission forecast takes 
into  account  (i)  a  systematic  under-execution  in  the  previous  years,  (ii)  the  weak  budgetary 
outturn  in  the  first  quarter  of  2017,  and  (iii)  a  more  prudent  assumption  on  the  military 
equipment deliveries in 2017. 

The  planned  unified  wage  law  (UWL),  currently  debated  by  the  parliament,  poses  a 
significant  risk  to  the  fiscal  forecast  in  2018  and  beyond,  with  a  potential  impact  on  the 
general government balance of up to -2% of GDP in 2018. Its final form and implementation 
schedule  were  not  known  at  the  cut-off  date  of  the  Commission  spring  2017  forecast. 
Therefore, the UWL has not been included in the Commission spring 2017 forecast, nor in the 
2017 Convergence Programme projection. 

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Table 2. Composition of the budgetary adjustment 

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2015201620172015OutturnCP 2016OutturnCP 2016CP 2017COMRevenue35.032.531.731.732.230.6of which:- Taxes on production and imports13.312.011.311.211.010.5- Current taxes on income, wealth, etc.6.66.56.56.66.66.4- Social contributions8.18.18.18.18.78.5- Other (residual)7.05.95.85.85.95.2Expenditure35.835.434.734.635.134.1of which:- Primary expenditure34.233.833.233.033.732.6of which:Compensation of employees7.78.18.27.98.48.7Intermediate consumption5.75.65.35.55.15.2Social payments10.611.410.711.211.712.0Subsidies0.50.50.40.50.40.4Gross fixed capital formation5.24.63.64.54.33.5Other (residual)4.63.65.03.43.92.9- Interest expenditure1.61.61.51.61.41.6General government balance (GGB)-0.8-2.9-3.0-2.9-2.9-3.5Primary balance0.9-1.3-1.5-1.2-1.6-2.0One-off and other temporary measures0.30.0-0.40.00.00.1GGB excl. one-offs-1.0-2.9-2.7-2.9-2.9-3.6Output gap1-1.3-0.4-0.10.0-0.10.7Cyclically-adjusted balance1-0.3-2.7-3.0-2.9-2.9-3.8Structural balance2-0.6-2.7-2.6-2.9-2.9-3.9Structural primary balance21.1-1.1-1.1-1.3-1.5-2.3(% of GDP)20162017Notes:1Output gap (in % of potential GDP) and cyclically-adjusted balance according to the programme as recalculated by Commission on the basis of the programme scenario using the commonly agreed methodology.2Structural (primary) balance = cyclically-adjusted (primary) balance excluding one-off and other temporary measures.Source:Convergence Programme (CP); Commission 2017 spring forecasts (COM); Commission calculations. 
 
 
 
 
 
 
Table 3. Debt developments 

In  2016,  the  general  government  debt-to-GDP  ratio  decreased  by  0.4%  of  GDP,  reaching 
37.6% and is projected by the Commission to increase to 40.9% of GDP by 2018. 

3. 

COMPLIANCE WITH THE ADJUSTMENT TOWARDS THE MTO  

Romania's MTO is a deficit of 1% of GDP in structural terms. 

On 12 July 2016, the Council addressed recommendations to Romania in the context of the 
European Semester. In the area of public finances the Council recommended Romania to limit 
the deviation from the MTO in 2016 and achieve an annual fiscal adjustment of 0.5 % of GDP 
in 2017 unless the MTO is respected with a lower effort. That recommendation is in line with 
the earlier Council recommendation from 14 July 2015, which required Romania to remain at 
the MTO in 2016. 

On  22  February  2017  Vice-President  Valdis  Dombrovskis  and  Commissioner  Pierre 
Moscovici sent a joint letter2 to the Romanian authorities in which they recalled that Romania 
was  estimated  to  have  significantly  deviated  from  its  MTO  in  2016,  while  the  Commission 
forecast pointed to further deterioration of the structural balance in 2017 and 2018. The letter 

2 https://ec.europa.eu/info/sites/info/files/letter_to_romanian_mof.pdf 

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201520162016201720172015OutturnCP 2016OutturnCP 2016CP 2017COMGross debt ratio138.039.137.639.838.039.3Change in the ratio-1.40.7-0.40.70.41.7Contributions2:1. Primary balance-0.91.31.51.21.62.02. “Snow-ball” effect-0.7-0.6-1.0-0.7-1.2-0.5Of which:Interest expenditure1.61.61.51.71.31.6Growth effect-1.5-1.5-1.7-1.6-1.8-1.5Inflation effect-0.9-0.7-0.8-0.8-0.7-0.53. Stock-flow adjustment0.20.0-1.00.20.10.3(% of GDP)20162017Notes:1 End of period.2 The snow-ball effect captures the impact of interest expenditure on accumulated debt, as well as the impact of real GDP growth and inflation on the debt ratio (through the denominator). The stock-flow adjustment includes differences in cash and accrual accounting, accumulation of financial assets and valuation and other residual effects. Source:Commission 2017 spring forecast (COM); Convergence Programme (CP), Comission calculations. 
 
 
 
                                                 
 
also  pointed  to  a  clear  risk,  based  on  the  Commission  forecast  for  2017  and  2018,  that  the 
deficit criterion for the purposes of the Treaty and of Regulation (EC) No 1467/97 would not 
be  fulfilled.  The  letter  recalled  that  the  Commission  would  reassess  Romania's  compliance 
with its obligations under the Stability and Growth Pact on the basis of the Commission 2017 
Spring  Forecast,  including  the  budgetary  data  for  2016  and  Romania's  2017  Convergence 
Programme. It recalled the importance that the necessary measures to ensure compliance with 
the deficit criterion and with the adjustment path towards the MTO were credibly announced 
by that time. 

In 2016, from a position of -0.6% of GDP in 2015, i.e. above the MTO, the structural balance 
deteriorated  to  -2.6%  of  GDP,  pointing  to  a  significant  deviation  from  the  recommended 
structural  adjustment  by  a  large  margin  (deviation  of  1.6%  of  GDP).  The  growth  of 
government expenditure, net of discretionary revenue measures and one-offs, was well above 
the  expenditure  benchmark,  also  pointing  to  a  significant  deviation  by  a  large  margin 
(deviation of -2.0% of GDP). The difference in the indicators is mainly explained by different 
annual  nominal  potential  GDP  growth  rates  used  in  their  computation.  Irrespective  of  that 
difference, both indicators confirm a significant deviation from the requirements in 2016.  

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Table 4. Compliance with the MTO or the required adjustment towards it 

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(% of GDP)2016Medium-term objective (MTO)-1.0Structural balance2 (COM)-2.6Structural balance based on freezing (COM)-2.5Position vis-a -vis the MTO3At or above the MTO2016COMCPCOMCPCOMRequired adjustment40.0Required adjustment corrected5-0.5Change in structural balance6-2.1-0.5-1.2-0.2-0.2One-year deviation from the required adjustment7-1.6-1.0-1.7-0.7-0.7Two-year average deviation from the required adjustment7-0.6-1.2-1.7-0.8-1.2Applicable reference rate83.9One-year deviation adjusted for one-offs9-2.0-1.1-1.7-0.7-1.1Two-year deviation adjusted for one-offs9-1.1-1.6-1.9-0.9-1.4PER MEMORIAM: One-year deviation10-2.9-0.7-1.2-0.7-1.1PER MEMORIAM: Two-year average deviation10-1.4-1.0-2.1-0.7-1.2Conclusion over one yearSignificant deviationSignificant deviationSignificant deviationSignificant deviationSignificant deviationConclusion over two yearsSignificant deviationSignificant deviationSignificant deviationSignificant deviationSignificant deviationSource:9 Deviation of the growth rate of public expenditure net of discretionary revenue measures, revenue increases mandated by law and one-offs from the applicable reference rate in terms of the effect on the structural balance. The expenditure aggregate used for the expenditure benchmark is obtained following the commonly agreed methodology. A negative sign implies that expenditure growth exceeds the applicable reference rate. Notes1 The most favourable level of the structural balance, measured as a percentage of GDP reached at the end of year t-1, between  spring forecast (t-1) and the latest forecast, determines whether there is a need to adjust towards the MTO or not in year t.  A margin of 0.25 percentage points (p.p.) is  allowed in order to be evaluated as having reached the MTO.10 Deviation of the growth rate of public expenditure net of discretionary revenue measures and revenue increases mandated by law from the applicable reference rate in terms of the effect on the structural balance. The expenditure aggregate used for the expenditure benchmark is obtained following the commonly agreed methodology. A negative sign implies that expenditure growth exceeds the applicable reference rate. 2  Structural balance = cyclically-adjusted government balance excluding one-off measures.3 Based on the relevant structural balance at year t-1.4 Based on the position vis-à-vis the MTO, the cyclical position and the debt level (See European Commission:Vade mecum on the Stability and Growth Pact, page 38.).6 Change in the structural balance compared to year t-1. Ex post assessment (for 2014) is carried out on the basis of Commission 2015 spring forecast. 7  The difference of the change in the structural balance and the corrected required adjustment. 8  Reference medium-term rate of potential GDP growth. The (standard) reference rate applies from year t+1, if the country has reached its MTO in year t. A corrected rate applies as long as the country is adjusting towards its MTO, including in year t. 5  Required adjustment corrected for the clauses, the possible margin to the MTO and the allowed deviation in case of overachievers.0.50.5Expenditure benchmark pillar1.04.3Conclusion0.50.5Convergence Programme (CP); Commission 2017 spring forecast (COM); Commission calculations.20172018Initial position1-3.9-4.0-3.9-Not at MTONot at MTO(% of GDP)20172018Structural balance pillar-1.0-1.0 
 
 
4. 

NEW ADJUSTMENT PATH TO THE MTO AND REQUIRED FISCAL EFFORT  

Based on the 2017 spring forecast, Romania is in normal economic times (as its output gap of 
0.7%  is  between  -1.5%  and  1.5%  of  potential  GDP).  Romania's  debt  is  below  the  60%  of 
GDP threshold. Romania's structural balance in 2016 is estimated to have been 1.6% of GDP 
away from its MTO of 1% of GDP.  

The  minimum  required  structural  effort  prescribed  by  Regulation  (EC)  No  1466/97  and  the 
adjustment  matrix3,  which  factors  in  the  prevailing  economic  circumstances  and  possible 
sustainability concerns, amounts to 0.5% of GDP.  

The Commission 2017 spring forecast projects a further deterioration of the structural balance 
by 1.3% of GDP in 2017. Therefore, a minimum structural improvement of 0.5% of GDP in 
2017  relative  to  the  2016  outturn  translates  into  a  need  to  adopt  structural  consolidation 
measures  of  a  total  yield  of  1.8%  of  GDP  in  2017  for  the  year  as  a  whole,  relative  to  the 
current 2017 baseline from the Commission spring 2017 forecast. Given the significant size of 
the  required  structural  consolidation  effort  resulting  from  the  minimum  SGP-required 
adjustment,  no  additional  required  adjustment  on  top  of  the  minimum  0.5%  requirement 
would appear warranted.  

Based on the Commission forecast, the above-mentioned 0.5% of GDP structural adjustment 
target  is  consistent  with  a  nominal  growth  rate  of  net  primary  government  expenditure  of 
3.3% in 2017, compared to the growth rate of 7.5% projected by the Commission. 

5. 

OVERALL CONCLUSION 

In  2016,  GDP  growth  reached  an  eight-year  high  of  4.8%,  driven  mainly  by  consumption, 
which  was  boosted  by  pro-cyclical  fiscal  policy  and  wage  hikes.  The  headline  deficit  more 
than tripled, to 3% from 0.8% of GDP in 2015, due to significant tax cuts and public wage 
increases. The structural deficit increased to 2.6% of GDP, from 0.6% of GDP in 2015, and 
deviated from Romania's MTO. The debt-to-GDP ratio remained below 60% of GDP.  

Both  the  structural  balance  and  the  expenditure  benchmark  pillars  point  to  a  significant 
deviation in 2016. An overall assessment appears to confirm that the observed deviation from 
the MTO in 2016 is significant.  

An improvement in Romania's structural balance by 0.5% of GDP in 2017 relative to the 2016 
outturn  would  put  Romania  on  an  appropriate  adjustment  path  towards  the  MTO.  Such  an 
improvement  is  consistent  with  the  nominal  growth  rate  of  net  primary  government 
expenditure not exceeding 3.3% in 2017. Such an adjustment seems also appropriate to ensure 
that Romania respects the 3% of GDP general government deficit threshold in 2017. 

3  “Commonly  agreed  position  on  Flexibility  within  the  SGP”,  formally  endorsed  by  ECOFIN  Council  on  12 
February 2016, available at: http://data.consilium.europa.eu/doc/document/ST-14345-2015-INIT/en/pdf 

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