THE ECONOMIST INTELLIGENCE UNIT

 | 

JOAN HOEY

  |  08.09.2015

Outlook for 2015-19

Macroeconomic policy since the global economic crisis of 2008-09 has largely corrected internal and external imbalances, but spending pressures are building again and further fiscal structural reforms are being demanded by the European Commission and the IMF.

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THE ECONOMIST INTELLIGENCE UNIT



JOAN HOEY

JOAN HOEY

REGIONAL EDITOR, EUROPE at THE ECONOMIST INTELLIGENCE UNIT

POLITICAL OUTLOOK
Political stability
Romania faces increasing political uncertainty as relations between the prime minister, Victor Ponta, and the president, Klaus Iohannis, appear to have broken down. The breakdown of relations follows Mr Ponta’s second appearance, on July 13th, before the Anti-Corruption Directorate (DNA) to face charges of forgery of private documents and of being an accessory to tax evasion and money-laundering. Prosecutors ordered a freeze on Mr Ponta’s assets up to the value of the alleged damages, and his status in the case was changed from that of a suspect to a defendant. In further signs of the growing tension between the president and the prime minister, Mr Iohannis refused to approve Mr Ponta’s first nomination for transport minister and also rejected the government’s proposed fiscal code, returning it to parliament for re-examination. Mr Iohannis has requested Mr Ponta’s resignation as prime minister.

 

So far, the ruling Social Democratic Party (SDP), the government and parliament have resisted pressure from the president to remove Mr Ponta. On June 9th the Chamber of Deputies (the lower house of parliament) rejected, by 231 votes to 120, a DNA request to remove Mr Ponta’s parliamentary immunity to permit a criminal investigation into him. At the same time, a vote of no confidence in the government, called by the president’s National Liberal Party (NLP), gained only 194 votes of the 278 required to be successful. Mr Ponta’s ability to survive politically until the next election, scheduled for late 2016, will depend on his capacity to retain the support of his party and his coalition partners. He has faced criticism for his decision to ‘step down’ temporarily from the presidency of the SDP to contest the charges against him and there are signs that the support of the junior governing party, the National Union for the Progress of Romania (UNPR, a party in an electoral alliance with the SDP, which sits as a single party in both parliamentary chambers) cannot be taken for granted.

 

Currently, the SDP and the UNPR control 260 of the 588 seats in the two chambers; they are supported by the Alliance of Liberals and Democrats (ALDE), comprising the Liberal Reformist Party and the Conservative Party, with 37 members in the two chambers. The ALDE was formed on June 19th under the leadership of Calin Popescu Tariceanu, the leader of the Senate (the upper house of parliament), who served as prime minister in 2004-08. The opposition NLP holds 177 seats, the Hungarian Union of Democrats in Romania (HUDR) has 25, the populist Democratic and Popular Group controls 11; and there are 27 independents and 17 representatives of national minorities. Mr Iohannis secured 258 votes in favour of his nomination of former prime minister Mihai-Razvan Ungureanu (NLP) as head of the Foreign Intelligence Service on June 30th. The appointment was opposed by the SDP, but some members of the UNPR may have voted for Mr Ungureanu. Mr Ponta said that he would consider resigning if the president gave a firm commitment to appoint a prime minister from the governing coalition and said that, if he were to resign, he would support the candidacy of Mr Tariceanu. However, Mr Tariceanu opposed the president’s defence proposals and is unlikely to prove acceptable to him.

 

Election watch
The next general election is scheduled for late 2016, and a presidential election will take place in 2019. Mr Iohannis won the November 2014 presidential election in a second-round run-off by a comfortable margin, with 6.3 million votes (54.4%) to Mr Ponta’s 5.3 million (45.6%). The election of Mr Iohannis reflected widespread disillusionment with the political elite, and the governing SDP in particular. The mobilisation behind him of large numbers of customarily abstaining voters in addition to the usual centre-right constituency suggests that the SDP will face a challenge at the 2016 general election. Mr Iohannis was the candidate of the Liberal Christian Alliance (LCA), comprising the NLP and the Democratic Liberal Party (DLP). The two parties have now merged, retaining the NLP name. If Mr Iohannis can rally the centre-right parties, they may have a chance of unseating the SDP. However, recent history suggests that they will find it hard to unite and present a coherent programme. Mr Ponta will count on his party benefiting from a ‘feelgood factor’ by the time of the election, stemming from rising household consumption and real GDP growth in 2015-16.


International relations
The European Commission monitors Romania’s progress under the co-operation and verification mechanism, with the focus on reforming the judiciary and tackling corruption. Parliament voted in February to allow the DNA to pursue the prosecution of Elena Udrea, a former minister for tourism and protégé of the previous president, Traian Basescu, on charges relating to three separate cases of alleged graft. However, in June parliament voted to protect the immunity of the prime minister after his indictment on corruption charges. The two votes suggest that the anti-corruption campaign is politically charged, with the potential to taint both sides of the political spectrum and to erode popular confidence in Romania’s institutions.

 

ECONOMIC POLICY OUTLOOK
Policy trends
Macroeconomic policy since the global economic crisis of 2008-09 has largely corrected internal and external imbalances, but spending pressures are building again and further fiscal structural reforms are being demanded by the European Commission and the IMF. The two institutions want the government to improve the absorption of EU funds to modernise public infrastructure, tackle long delayed reform of the state-owned enterprise sector and address weaknesses in the financial sector.


Romania’s stand-by arrangement with the IMF, which runs to September 2015, has effectively lapsed. The IMF, together with the European Commission, criticised proposals by the Chamber of Deputies to cut the basic rate of valueadded tax (VAT) from 24% to 19% by January 1st 2016. The Commission referred the proposals to its Economic and Financial Affairs Council (Ecofin) on July 14th. The tax changes are likely to result in a budget deficit in excess of 3% of GDP in 2016, breaching EU fiscal rules. The government cut the rate of VAT on foodstuffs (excluding alcoholic beverages and tobacco) from 24% to 9% from June 1st, and on draught beer to 9% on June 10th). As the 2016 general election nears, the government is likely to make further changes to tax rates in an attempt to win over voters.

 

Fiscal policy
Parliament approved a consolidated budget for 2015, after tough negotiations between the Romanian authorities and the IMF, the EU and the World Bank as part of the third review of the IMF stand-by arrangement (SBA). This allows for a deficit of 1.83% of GDP on a cash basis, equivalent to a deficit of 1.5% of GDP according to ESA 2010 ‘accruals’ methodology. The government plans to reduce the annual consolidated budget deficit to 1.1% of GDP in 2016-17 and 0.9% of GDP in 2018, in line with commitments under the EU’s fiscal compact to maintain a structural deficit of about 1% of GDP. The government argues that improvements in revenue collection and stricter expenditure control have created leeway for tax cuts to boost consumption and growth. However, planned tax cuts will have a negative impact on revenue generation in 2015-16, jeopardising official deficit targets.

  • Consolidated budget revenue rose by 10.8% year on year in the first five months of 2015, to Lei 93.2 billion (US$23.4 billion), while expenditure increased by 1.4% to Lei 86.8 billion, resulting in a budget surplus of Lei 6.3 billion, equivalent to 0.9% of projected annual GDP.
  • VAT receipts grew by 17.5% year on year in the first five months, to Lei 25.9 billion, equivalent to 3.4% of projected annual GDP, and accounted for 52% of the increase in revenue in the first five months.
  • The Economist Intelligence Unit believes that VAT revenue would have risen to about 8.2% of GDP in 2015 without the cut in VAT on foodstuffs, which will reduce VAT receipts to around 7.7% of GDP in the full year.
  • We forecast that the reduced rate of VAT on foodstuffs will result in a reduction in budget revenue of just below 1% of GDP in a full year (or 0.5% of GDP in 2015), assuming no significant reduction in tax evasion resulting from the lower rate.
  • We forecast that, from 2016, the cut in the basic VAT rate from 24% to 19% on non-foodstuffs will result in a reduction in budget revenue equivalent to 1.2% of GDP in a full year, although improved tax collection may partly offset this.
  • We forecast that the changes in all VAT rates will reduce budget revenue by just above 2% of GDP in 2016.
  • Cuts in social security contributions could also reduce budget revenue by a further 0.6% of GDP in 2017.

On this basis, we forecast that the proposed VAT cuts will lead to a consolidated budget deficit of 2.3% of GDP in 2015 (cash basis) and a deficit of more than 3% of GDP in 2016. Over the medium term, we expect fiscal consolidation to be broadly maintained, but we do not expect the authorities to meet the deficit target of 1% of GDP.

 

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