RECENT ECONOMIC DEVELOPMENTS
Romania’s economy grew by 5.8% in the first half of 2017, the fastest in the EU. Growth was led by private consumption (up 7.4% year-on-year [y-o-y]), fueled by a reduction in the standard value added tax (VAT) rate from 24 to 20% in January 2016 and by minimum and public sector wage and pension increases. Investment growth was timid (up 1.1%), reflecting the poor performance of public investment mainly due to the drop in EU investment funding.
Inflation is on an upward trend, driven by the pickup in private consumption, but it remains within the boundaries of the Central Bank. Annual headline inflation moved into positive territory in February 2017 and reached 1.2% in August, as the base effect of the VAT cut dissipated. The National Bank of Romania (NBR) Board maintained the policy rate at 1.75% in August, amid early signs of corporate credit growth recovery (up 4.3% as of July 2017) and concerns over the outlook of the fiscal and income policy stance. Household credit grew by 6.6% y-o-y in July 2017, supported by the fiscal stimulus, labor market improvements, and low interest rates.
The labor market strengthened further on the back of strong economic growth and fiscal relaxation. Real wages increased by 13.5% y-o-y as of July 2017, and unemployment increased marginally by 0.2 percentage points from an eight-year low value of 5% registered in June 2017. Nonetheless, the low employment rate of 61.2% in the first quarter of 2017 reflects persistent structural rigidities in the labor market.
Fiscal policy has remained pro-cyclical in 2017. The budget execution posted a deficit of 0.63% of GDP in July 2017, an increase of 0.4 percentage points compared to the same period last year. The widening of the deficit reflects an 11.4% increase in public expenditure and a lower-than-expected revenue collection (up 9%), particularly from VAT (down 4.6%). The increase in current spending was driven by hikes in employee compensation (up 20.3%) and social assistance spending (up 10.7%), while public investment spending contracted by 34.4%.
Growth is expected to remain solid in 2017, fueled by additional fiscal relaxation measures. In early 2017, the VAT rate was further cut to 19% and supplementary measures were adopted by the Government, including an increase of 16% in the minimum wage and further tax reductions for pensions below a certain threshold. The additional pickup in consumption is expected to widen the current account deficit to 3.1% in 2017 from 2.4% at end-December 2016.
The NBR projects a gradual increase in inflation toward 2% at end-2017. The Government aims to maintain the fiscal deficit below 3% of GDP in 2017 through several fiscal measures, including increasing excise duties for fuels and requiring selected SOEs to pay dividends in advance of their 2017 profits. Exceeding the deficit limit of 3% of GDP would place Romania into the Excessive Deficit Procedure of the EU. The widening of the fiscal deficit will push public debt to 49.4% of GDP at end-2019 from 44.6% in 2016.
Nevertheless, public debt remains one of the lowest in the EU. Continued strong private consumption growth, aided by a lower VAT rate, growth in employment and real wages, and the new minimum inclusion income, should boost real incomes and lead to further declines in poverty incidence. The US$5.50/day 2011 purchasing power parity (PPP) poverty rate is projected to decline to 24.5% in 2017, 23.3% in 2018, and 22.4% in 2019. This is consistent with the rate trend for those at risk of poverty or social exclusion based on the EU’s statistics on income and living conditions (SILC), indicating that severe material deprivation has decreased significantly.
However, income inequality has increased, partially due to the diminishing re-distributive effect of the tax and transfer system. The planned introduction of a minimum social inclusion income program in 2018 aims to consolidate three means-tested programs, doubling the current budget and increasing the adequacy and coverage of benefits.
Last Updated: Oct 06, 2017