RECENT ECONOMIC DEVELOPMENTS
Romania’s economy grew by 4.8% in 2016, the highest since 2008 and the third fastest in the EU. Growth was led by private consumption (up 6.8% year-onyear [y-o-y]), which was fueled by a reduction in the standard value added tax (VAT) rate from 24 to 20% in January 2016 and by increases in the minimum and public sector wages and pensions. Investment growth stalled as public investment declined due to the drop in EU investment funding.
Inflation fell to a record low in 2016 and remains subdued, supporting an accommodative monetary policy. Annual headline inflation moved into positive territory in February 2017 (0.2%), as the base effect of the VAT cut dissipated. The National Bank of Romania (NBR) maintained the policy rate at 1.75% in February, amid negative corporate credit growth (down 3.5% y-o-y as of January 2017) and increasing concerns over the further relaxation of the fiscal stance. Household credit grew by 4.6% y-o-y in January 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 12% y-o-y and unemployment fell to 5.5%, an eight-year low, as of end-December 2016. Nonetheless, the low employment rate of 61.6% in the fourth quarter reflects persistent structural rigidities in the labor market.
Fiscal policy turned pro-cyclical in 2016. The budget deficit was 2.4% of GDP at end-2016, lower than the initial target of 2.8% but on an upward trend due to the fiscal stimuli. On the revenue side, improvements in the collection of corporate income tax (up 11.7% y-o-y), social contributions (up 6.3% y-o-y), and personal income tax (up 4.2% y-o-y) partially offset the reduction in VAT revenues (down 9.6% y-o-y). Low public investment spending (down 31.6% y-o-y at endDecember), especially from EU funds, contributed to the lower-than-expected deficit.
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.
Coupled with a positive output gap and increased import prices, aggregate demand will drive inflation upward. The NBR projects a gradual increase in inflation toward 1.7% at the end of 2017. The consolidated budget deficit is projected to go above 3% of GDP in 2017, placing Romania on a trajectory toward reentering the EU’s Excessive Deficit Procedure. The widening of the fiscal deficit will push public debt to 42.8% of GDP at end-2019 from 39.9% in 2015. 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$2.50/day 2005 purchasing power parity (PPP) poverty rate is projected to further decline to below 5% in 2019, and the US$5/day 2005 PPP poverty rate is projected to decline to 14.7%.
This is consistent with the rate trend for those at risk of poverty or social exclusion (AROPE) based on EU statistics on income and living conditions, indicating that severe material deprivation decreased significantly. However, income inequality has increased, partially due to the diminishing redistributive effect of the tax and transfer system. The planned introduction of a minimum social inclusion income program in 2018 aims to consolidate 3 means-tested programs, doubling the current budget and increasing the adequacy and coverage of benefits.
Last Updated: Apr 20, 2017