REPORT FROM THE COMMISSION TO THE COUNCIL Commission report to the Council pursuant to article 11(2) of regulation EC 1466/97 on the enhanced surveillance mission in Romania
Date: 2017-10-24
Institutions: Directorate-General for Economic and Financial Affairs, European Commission
Subjects: Romania, budget deficit, economic convergence, economic reform, financial control, gross domestic product, multilateral surveillance, public debt, public finance, stability programme

EN 

   EN 

   EUROPEAN COMMISSION  Brussels, 24.10.2017  COM(2017) 629 final   REPORT FROM THE COMMISSION TO THE COUNCIL Commission report to the Council pursuant to article 11(2) of regulation EC 1466/97 on the enhanced surveillance mission in Romania  
 
 
This  report  on  an  enhanced  surveillance  mission  in  Romania  is  transmitted  to  the  Council 
pursuant to Article -11(4) of Regulation (EC) No 1466/971. As foreseen by Article -11(5) of 
Regulation  (EC)  No  1466/97,  the  provisional  findings  of  that  mission  have  been  previously 
transmitted to Romania for comments. 

Romania – Significant Deviation Procedure 
Enhanced surveillance mission, 26-27 September 2017 

Report 

1. Introduction 

As a consequence of the significant deviation from its medium-term budgetary objective 
(MTO) in 2016, a Significant Deviation Procedure (SDP) was launched for Romania in 
spring 2017. The Member State's structural deficit increased to 2.5% of GDP in 2016, from 
below  1%  in  2015,  due  to  significant  cuts  in  indirect  taxes  and  increases  in  public  sector 
wages.  As  a  consequence,  on  22  May  2017,  the  Commission  issued  a  warning  to  Romania 
and proposed to  the Council to  launch a SDP. In  its SDP recommendation,  approved on 16 
June  2017,  the  Council  asked  Romania  to  take  measures  to  ensure  that  the  nominal  growth 
rate of net primary government expenditure does not exceed 3.3% in 2017. This corresponds 
to  an  annual  structural  adjustment  of  0.5%  of  GDP,  which  is  the  minimum  effort  required 
under the preventive arm of the Stability and Growth Pact (SGP). It translates into a need for 
corrective measures equivalent to 1.8% of GDP in 2017, as compared to the baseline from the 
Commission's spring 2017 economic forecast. Romania has reported to the Council as asked 
on  the  action  taken  in  response  to  the  Council  recommendation  by  15  October  2017.  The 
Commission is now assessing the content of Romania's submission.   

The  enhanced  surveillance  mission  by  the  Commission  took  place  on  26-27  September 
2017. The mission was carried out on the basis of Article -11(2) of Regulation (EC) 1466/97. 
The  mission  met  the  Minister  of  Finance  Ionuţ  Mişa,  the  governor  of  the  National  Bank  of 
Romania  Mugur  Isărescu,  members  of  the  Fiscal  Council  of  Romania  and  members  of  the 
budgetary  committees  of  the  Romanian  Parliament.  The  aim  of  the  mission  was  to  learn  in 
detail about the fiscal actions planned by the Romanian authorities, to increase the visibility of 
the fiscal risks and to encourage compliance with the SGP. The mission also assessed fiscal 
developments and budget execution in 2017.  

2. Findings of the mission 

It  was  understood  that  the  Romanian  authorities  do  not  intend  to  act  upon  the  SDP 
recommendation.  The  Minister  of  Finance  confirmed  that  the  target  for  2017  remains  the 
headline deficit of 3% of GDP, while a structural adjustment in 2017 is not a priority. In the 
2017  budget  rectification,  adopted  by  the  government  in  mid-September  2017,  the  headline 
deficit target has been kept at 2.96% of GDP, while the underlying macroeconomic projection 

1 Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance 
and coordination of economic policies, OJ L 209, 2.8.1997, p. 1 

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improved. This indicates a deterioration of the underlying structural deficit as compared to the 
original 2017 budget,  which already planned an expansionary fiscal stance. The Minister  of 
Finance argued that the SDP recommendation came late in the year, leaving limited scope to 
implement the recommended structural adjustment. 

The recently adopted 2017 budget rectification also raises concerns as to the quality of 
public finances. The main elements of the budget rectification are: (i) an upward revision of 
GDP  growth  from  5.2%  to  5.6%; (ii)  the  public  deficit  (cash)  target to  be  kept  at  2.96%  of 
GDP;  (iii)  tax  revenues  revised  downwards  (driven  by  a  downward  revision  of  VAT  and 
corporate  profit  tax),  (iv)  social  contributions  and  non-fiscal  revenues  (i.e.  dividends  from 
State-owned  enterprises  (SOEs))  revised  upwards.  The  increase  in  dividends  from  SOEs  is 
partially due to a new request for dividends from profits retained in previous years; (v) on the 
expenditure  side,  capital  expenditures  were  reduced  by  roughly  a  quarter;  (vi)  while  public 
sector wages and social benefits were increased. In terms of budget composition, Romania has 
adopted  policies  that  increase  consumption  in  the  short  term  (indirect  tax  cuts,  increases  of 
public  wages)  and  are  difficult  to  reverse,  rather  than  policies  aimed  at  boosting  long-term 
economic growth, such as improving the absorption of EU funds or increasing the quality of 
public investment. 

The authorities aim to maintain a headline deficit of 3% of GDP in 2018. The Minister of 
Finance stated two objectives for 2018: a primary objective of maintaining a headline deficit 
of 3% of GDP, and, as a secondary objective, a reduction in the structural deficit by 0.5% of 
GDP.  The  mission  observed  that,  given  the  positive  and  increasing  output  gap,  keeping  the 
headline  deficit  at  3%  of  GDP  in  2018  would  imply  a  deterioration  in  the  structural  fiscal 
position. 

According to the Commission projections, following the usual no-policy change scenario, 
the headline deficit is likely to increase in 2018 to substantially above 3% of GDP, driven 
by  further  significant  increases  in  public  wages.  In  June  2017,  the  Romanian  parliament 
approved  the  Unified  Wage  Law.  That  law  seeks  to  harmonise  the  currently  fragmented 
public sector wage grids and defines the salary for each public sector position. It defines the 
path  to  reach  that  goal  and  defines  2022  as  the  year  for  the  full  implementation  of  the  new 
wage  system.  Wages  will  be  increased  by  25%  for  all  government  employees  in  January 
2018, with annual increases of 25% of the difference between the January 2018 salary and the 
target  2022  salary  thereafter.  The  health  and  education  sectors  will  receive  additional 
increases  in  2018,  on  top  of  the  general  25%  increase  of  January  2018.  As  a  consequence, 
based on the no-policy change scenario, the headline deficit is likely to increase significantly 
above 3% of GDP, possibly to somewhat above 4% of GDP (a more exact estimate will be 
obtained during the autumn forecast exercise). Therefore, to achieve the stated 2018 targets, 
let alone to comply with the preventive arm of the SGP, the authorities need to adopt further 
measures. 

The  authorities  plan  to  shift  social  contributions  entirely  onto  employees,  in  order  to 
cushion the fiscal impact of the Unified Wage Law. The intention is to increase the social 
contributions  rate  paid  by  employees  on  their  gross  wages.  The  government  plans  to 
accompany  that  shift  with  a  cut  of  the  overall  social  contributions  rate,  from  the  current 

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22.75%  for  employers  and  16.5%  for  employees  to  36%  for  employees,  and  to  cut  the 
Personal Income Tax rate from 16% to either 12% or 10%. The government is also seeking a 
legal  solution  that  would  ensure  that  private  sector  employers  increase  the  gross  wages  of 
their employees so that their net wages do not bear the cost of the social contributions shift. 

The  government  is  also  considering  a  reversal  of  the  2008  pension  reform,  which 
introduced  the  second  pension  pillar.  The  authorities  are  considering  a  reduction  of  the 
transfer of social contributions to the second pension pillar, which under European System of 
Accounts (ESA) rules is classified outside of general government. Those transfers amount to 
around 0.8% of GDP annually. Such a measure would decrease the fiscal deficit in the short 
term.  However,  that  fiscal  gain  would  dissipate  in  the  long  term  as  the  social  contributions 
diverted  from  the  second  pillar  would  be  accompanied  by  an  obligation  to  pay  old-age 
pensions  in  the  future.  In  addition,  such  a  reversal  could  have  negative  implications  for  the 
viability  of  the  pensions  system  and  for  the  development  of  capital  markets.  The  mission 
cautioned  against  enacting  such  profound  changes  to  the  pension  system  in  a  hasty  way, 
without  proper  analysis  and  only  for  short-term,  deficit-reducing  reasons.  Nationalisation  of 
the  assets  accumulated  in  the  second  pillar,  which  under  ESA  rules  would  not  affect  the 
government deficit, does not seem to be considered at this point. 

The mission also discussed the recently adopted split VAT payment mechanism.  At the 
end  of  August  2017  the  government  adopted  an  emergency  ordinance  amending  the  Fiscal 
Code.  The  ordinance,  aimed  at  improving  tax  compliance,  obliges  all  VAT  payers  to  use 
separate  accounts  for  VAT  purposes  from  January  2018.  The  mission  stressed  that  such  an 
obligatory mechanism may require a prior derogation from the VAT Directive2. The Ministry 
of Finance disputed the need for a derogation and argued that the Commission does not have 
accurate information about that measure.  

The National Bank of Romania confirmed the pro-cyclical fiscal policy, contributing to 
the Commission's concerns regarding the current policy-mix. Romania is in the middle of 
a  large  economic  upswing,  which  is  the  ideal  time  to  rebuild  fiscal  buffers  for  an  eventual 
downturn. However, the fiscal position of Romania has been highly expansionary. From this 
perspective,  Romania's  fiscal  policy  appears  imprudent  and  strongly  conditions  monetary 
policy.  

The mission exchanged views with members of the Romanian parliament's committees 
on  budget  and  fiscal  policy.  Members  from  both  the  ruling  coalition  and  the  opposition 
shared  concerns  regarding  the  composition  of  the  budget,  in  particular  regarding  public 
investment  cuts,  and  their  impact  on  long-term  growth.  The  chair  of  the  joint  committees 
seemed  to  consider  there  was  a  need  to  change  the  direction  of  fiscal  policy  and  start  a 
structural adjustment in 2018. 

The Fiscal Council shared the Commission's concerns regarding the fiscal outlook. 
According to the Fiscal Council, the structural deficit will substantially deteriorate in 2018 
and the headline deficit is projected to breach the 3% of GDP threshold in the absence of 
countervailing fiscal measures. 

2 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, OJ L 347, 11.12.2006, p. 1. 

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STATISTICAL ANNEX 
(Forecast data based on the European Commission 2017 spring forecast) 3 

Table 1: Key economic indicators overview 2009-2018 

3 The Commission forecast will be updated in November 2017. 

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200920102011201220132014201520162017*2018*Gross Domestic Product(annual percentage change, unless otherwise indicated)Nominal GDP (in bn RON)511534565595637668711761806860Real GDP-7.1-0.81.10.63.53.13.94.84.33.7Private Consumption-10.11.00.81.20.74.76.07.47.55.6Public Consumption3.7-4.90.60.4-4.60.80.14.53.73.0Gross fixed capital formation-36.6-2.42.90.1-5.43.28.3-3.30.73.2Exports-5.315.211.91.019.78.05.48.36.96.2Imports-20.712.610.2-1.88.88.79.29.89.38.1Contribution to GDP growthDomestic demand-19.9-0.91.40.9-1.73.85.74.45.34.7Inventories5.90.2-0.2-1.41.6-0.3-0.21.10.30.0Net exports6.9-0.1-0.11.13.6-0.3-1.6-0.7-0.5-0.3PricesHICP inflation (average)5.66.15.83.43.21.4-0.4-1.11.13.0HICP inflation (year-end, quarterly)4.57.83.44.71.31.4-1.0-0.12.03.0Labour marketTotal employment9181915690828645856986358558848185438573Unemployment rate (harmonised:15-74)6.57.07.26.87.16.86.85.95.45.3General Government Accounts(in percent of GDP)Government deficit, cash definition **-7.1-6.3-4.2-2.5-2.5-1.7-1.4-2.4-3.0-3.0Government deficit, ESA2010 definition-9.5-6.9-5.4-3.7-2.1-1.4-0.8-3.0-3.5-3.7Gross debt, general government, ESA2010 definition23.229.934.237.337.839.438.037.639.340.9Balance of payments(in percent of GDP)Current account balance ***-4.1-4.5-4.4-4.2-0.6-0.1-0.6-2.4-2.8-2.9Trade balance***-6.4-6.1-5.6-5.0-0.8-0.4-0.6-0.9-1.9-2.3Capital and financial account balance-3.9-4.2-3.0-1.13.34.73.93.4n.a.n.a.FDI balance-2.8-1.8-1.3-1.9-2.0-1.8-1.8-2.7n.a.n.a.Net international investment position-62.1-62.3-64.2-67.9-61.6-56.8-53.8-49.4-47.8n.a.Foreign exchange reserves (in bn Euro)28.332.433.231.232.532.232.234.235.2n.a.Gross external debt67.472.974.175.568.063.057.554.853.2n.a.Monetary and exchange rate developmentsBroad money M3 (annual % change, end of the period)9.06.96.62.78.88.49.39.711.7n.a.NBR policy rate (in %, end of period)8.006.256.005.254.002.751.751.751.75n.a.Exchange rate (lei/euro, end of period)4.234.284.324.434.484.484.524.544.60n.a.REER (Unit Labour Costs deflator, % change)-13.030.99-6.54-5.140.863.43-6.451.12n.a.n.a.*** Current account and trade balances are reported based on the latest Commission forecast using National Accounts Data.Notes:**   2017 and 2018 are projections from the Romanian authorities.  *   Forecasts or latest valuesSource: BNR and European Commission 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                            
Table 2: General government accounts 2015-2018 

Table 3: General government balance cyclical adjustment 

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ESA code201520162017*2018*   1. Taxes on production and importsD213.311.310.510.5   2. Current taxes on income and wealthD56.66.56.46.6   2a.  - of which, paid by households and NPISH3.63.63.53.5   2b.  - of which, paid by corporations3.02.92.93.0   3. Social contributionsD618.18.18.58.4   4. Sales and other current revenue4.44.33.73.9   5. Total current revenue (1+2+3+4)32.430.229.129.4   6. Compensation of employeesD17.78.28.78.7   7. Intermediate consumptionP25.75.35.25.2   8. Social transfers in kind supplied via market producers0.90.90.90.9   9. Social transfers other than in kindD6210.610.711.111.3  10. InterestD411.61.51.61.6  11. SubsidiesD30.50.40.40.4  12. Other current expenditure2.52.51.92.2  13. Total current expenditure (6+7+8+9+10+11+12)29.429.529.730.3  14. Gross saving (5-13)B8g2.90.7-0.6-0.9  15. Capital Transfers, receivedD92.71.51.62.1  16. Gross fixed capital formationP515.23.63.53.9  17. Other capital expenditure1.21.61.01.0  18. Total government revenue (5+15)TR35.031.730.631.5  19. Total government expenditure (13+16+17)TE35.834.734.135.2  20. Net lending (+) / net borrowing (-) (18-19)EDP B9-0.8-3.0-3.5-3.7Note:* European Commission spring 2017 forecastSource: European commission200920102011201220132014201520162017*2018*Government balance (ESA-2010)-9.5-6.9-5.4-3.7-2.1-1.4-0.8-3.0-3.5-3.7Primary balance-8.0-5.4-3.8-1.9-0.30.30.9-1.5-2.0-2.0Cyclically adjusted balance-8.8-5.5-4.1-2.0-1.0-0.5-0.3-3.0-3.8-3.9Cyclically adjusted primary balance-7.3-4.0-2.5-0.20.81.11.3-1.5-2.2-2.3Structural government balance-5.6-2.9-2.5-1.0-0.6-0.6-2.6-3.9-4.0GDP growth-7.1-0.81.10.63.53.13.94.84.33.7Potential growth1.91.31.11.81.72.12.83.53.53.6Output gap-2.0-4.0-4.0-5.0-3.3-2.4-1.3-0.10.70.8Note:* European Commission spring 2017 forecastSource:  European commission