Explanatory Memorandum to COM(2013)708 - Precautionary EU medium-term financial assistance to Romania - Main contents
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| dossier | COM(2013)708 - Precautionary EU medium-term financial assistance to Romania. |
|---|---|
| source | COM(2013)708  |
| date | 10-10-2013 |
After a joint EU-IMF medium-term financial assistance programme for Romania from spring 2009 to spring 2011, during which EUR 5 billion were disbursed on the European side and EUR 12.9 billion by the IMF, the Council of the European Union adopted on 12 May 2011 a decision on a follow-up precautionary programme, making available EU medium-term financial assistance of up to EUR 1.4 billion for Romania[1]. In the second programme, which was also a joint EU-IMF programme, no funds were disbursed either by the EU or by the IMF in line with its precautionary character.
On 4 July 2013, in the light of remaining risks to its balance of payments, the Romanian authorities requested a third EU medium-term financial assistance programme, again jointly with an IMF Stand-By Arrangement. The EU and IMF assistance is expected to be treated as precautionary, with no actual disbursements foreseen. On 9 July, the EFC responded favourably to this request and mandated the Commission to negotiate a new joint EU-IMF precautionary programme.
From 17 to 31 July 2013, the Commission services conducted with the IMF staff a joint negotiation mission to Bucharest. Staff-level agreement on the modalities and contents of a new programme was reached. A new programme would continue to provide support to the economic programme of the government aiming, among other things, at consolidating macroeconomic, fiscal and financial stability, increasing the resilience and the growth potential of the economy, enhancing administrative capacity, reforming the tax administration and improving public financial management and control. A new programme would run for 24 months and would be composed of precautionary assistance by the European Union of up to EUR 2 billion and by the IMF of up to SDR 1.75 billion (around EUR 2 billion) supported by a stand-by arrangement. In addition, the World Bank will continue providing earlier committed support of EUR 891 million, of which EUR 514 million is still to be disbursed.
Contents
- 2. Macroeconomic development and outlook
- 3. Public finances
- 4. Financial markets and banking sector developments
- 5. Balance of payment and external financing requirements
- 6. EU support under the balance-of-payments facility comes as part of an international effort
- 7. Main contents of a new programme
- A: Fiscal consolidation
- B: Fiscal governance and structural fiscal reform
- C: Public debt management
- D: Financial sector regulation and supervision
- E: Structural reforms
- F: Monetary Policy
Romania has registered positive economic growth since 2011. Recent developments suggest that growth in 2013 will be at about 2%, somewhat stronger than the 1.6% projected in the Commission's spring forecast. A stellar export performance (mainly on account of the automotive industry and services) and a good harvest are the main drivers of growth. These positive trends, however, mask weak domestic demand, with consumption being flat and investment contracting in the first half of 2013.
Going forward, growth is expected to gradually strengthen as structural reforms start paying off, EU funds absorption improves, and exports remain strong as the European economy recovers. Assuming an average harvest, growth is projected to be slightly above 2% in 2014. Domestic demand is expected to be the main driver of growth, driven by investment and private consumption, while net exports is projected to have a small negative contribution, as imports are expected to pick up in 2014 on the back of strengthening domestic demand.
Inflation, as measured by the HICP, remained high, at around 6%, in Romania in 2009-2011, but came down in 2012 to an average of 3.4%. Upward price pressures, however, became stronger again towards the end of 2012 and in the first half of 2013. Inflation is expected to subside during the second half of 2013 thanks to a sharp drop in food prices and a reversal of base effects, and to fall below 3.5% by end-2013, thus within the central bank's target range (2.5% ±1pp). A further deceleration is expected in 2014.
Romania has successfully consolidated its public finances over recent years, reducing its budget deficit from 9% of GDP in 2009 to just below 3% in 2012. This achievement allowed the Council, on 21 June 2013, to abrogate the excessive deficit procedure for Romania. A new programme would support the government's further fiscal consolidation efforts which aim to reaching Romania’s medium-term objective (MTO) of a structural budget deficit of 1% of GDP by 2015. The authorities remain committed to the previous programme's deficit target of 2.4% in ESA terms for 2013. In 2014, further consolidation in line with the Stability and Growth Pact (SGP) requirements is planned. Based on current indications, Romania would target a 2% deficit in ESA terms in line with its 2013 update of its convergence programme.
The July negotiation mission agreed on the mid-year budget rectification allowing for some shifts in revenue and expenditure while maintaining the overall deficit target for 2013 of 2.3% in cash and 2.4% in ESA terms. The revised budget caters for lower revenues and lowers domestic capital investments, reduces provisions for corrections related with EU Funds, and lowers transfers to other public administration units. Regarding the 2014 budget, the authorities are looking into ways to increase revenues, mainly via base broadening. On the expenditure side, one important challenge is the phasing in of the Unified Wage Law agreed under the first programme.
With the main part of the required fiscal consolidation having been achieved, the focus of a new programme will be on improving fiscal governance. It will aim to upgrade the fiscal framework to bring it in line with Fiscal Compact requirements, along with a number of other improvements to the content of the Fiscal Strategy and to the transparency of the budgeting process. It will require improvements in annual and medium-term capital budgeting, the finalisation of the commitment control system (to prevent new arrears), as well as improvements in tax administration aimed at more efficient tax collection.
Financial market conditions have significantly improved since the summer of 2012 amid an improvement in global market sentiment and following the stabilisation of the domestic political situation towards year-end. It has moved broadly in tandem with the regional peers, and remained relatively favourable in the first half of 2013. The 5-year CDS sovereign spreads for Romania dropped from nearly 500 basis points in May 2012 to below 200 bps in early January 2013, and it has hovered slightly above 200 bps since end-June 2013. After substantial losses in May 2012 the BET stock market index recovered until end-2012; it has been volatile since then but gained around 10% until early-September 2013.
Notwithstanding the upward trend in impaired assets (the non-performing loans (NPL) ratio reached 20.3% in June 2013), the banking sector’s capitalisation remained at reassuring levels (the capital adequacy ratio stood at 14.7% in June). Risks associated with increasing NPLs have been mitigated by a prudent loan-loss provisioning policy, although provisions continue to put a strain on profitability (return on equity reached 6% in H1 2013 after 3 years of losses). The central bank continues to closely oversee banks with parents from peripheral euro-area countries which have maintained sufficient capital buffers. The spill-overs from the crisis in Cyprus were mitigated through the agreement to transfer the local deposit base of the Romanian branch of Bank of Cyprus to Marfin Bank, the subsidiary of the Laiki Group, the deleveraging process of foreign banks and the reduction in parent bank funding (-14.6% since December 2012., albeit in line with regional developments and overall conducted in an orderly fashion, continue to require close attention by the supervisor.
Romania is expected to maintain full access to sovereign debt markets over the envisaged programme period (24 months) barring adverse external developments. CDS spreads have reached their lowest levels since 2010. The current-account deficit is expected to decrease from around 4% of GDP in 2012 to around 2% in 2013, mainly thanks to a decline in trade deficit.
Under the baseline scenario no sovereign or external financing gap should materialise in the next two years. However, Romania remains vulnerable to exchange-rate volatility and volatile international capital movements. In an adverse scenario, the financing of the current account could become difficult and sovereign market access could be impeded. In the latter case, a first line of defence would be the Treasury’s cash buffer (about 6-month of financing needs) and to a lesser extent the NBR's international reserves. Should Romania experience protracted and acute financing difficulties, the precautionary programme could be activated and the funds available (EUR 2 bn from the EU disbursable in two EUR 1 bn instalments and up to EUR 2 bn from the IMF Stand-By Arrangement) would allow to cover sovereign financial and budgetary commitments. A new programme would also provide reassurance to the financial markets that Romania is committed to an ambitious economic reform agenda.
In the light of remaining vulnerabilities and risks to its balance of payments and conditional on the Romanian authorities' commitment to implement a programme of fiscal, financial and structural adjustment, the Commission, after having consulted the Economic and Financial Committee (EFC) on 3 October 2013, recommends the Council to adopt a Decision granting further mutual assistance to Romania as foreseen by Article 143 of the Treaty (TFEU). The Romanian government shall implement its economic programme in order to deal with the remaining vulnerabilities, to mitigate remaining threats to the sustainability of its balance of payments and shall develop the necessary capacity to design and implement economic policies without international support.
Furthermore, the Commission, after consulting the EFC, proposes the Council to adopt a Decision providing precautionary EU medium-term financial assistance of up to EUR 2 billion to Romania so as to underpin the sustainability of Romania's balance of payments. Activation of the precautionary Union financial assistance and disbursements may be requested until 30 September 2015.
The new precautionary financial assistance provides support to the economic programme of the government aiming, inter alia, at consolidating macroeconomic, fiscal and financial stability, increasing the resilience and the growth potential of the economy, enhancing administrative capacity, reforming the tax administration, and improving public financial management and control. The specific economic policy conditionality will be set out in a Memorandum of Understanding (MoU) to be concluded by the Commission with the Romanian authorities. It will preserve the achievements of the previous two programmes and will carry over the yet unfulfilled conditions from the second programme.
Following the correction of its excessive deficit, Romania is expected to reduce its structural budget balance in line with SGP requirements until it reaches its medium-term objective of a structural general government deficit of 1% of GDP by 2015, and maintain it thereafter. Furthermore, the programme will continue efforts to prevent the build-up of government arrears, both at central and local government level. The public sector wage bill will need to stay on a sustainable footing, limiting wage growth as well as public sector employment levels.
To firmly anchor fiscal consolidation, the programme will involve a further strengthening of the fiscal governance framework.. The implementation of the Fiscal Compact is crucial in this respect, as well as improvements in multi-annual budgetary planning will ensure a more sustainable fiscal policy.
The government will be supported by extensive technical assistance provided by the IMF and the World Bank in the area of public financial management and control. The implementation of a commitment control system, which will be rolled out in several steps, will help ensure the reduction and control of arrears. In the health sector, budget control mechanisms will be strengthened through improved reporting and monitoring frameworks, in particular with regard to hospitals and pharmaceutical spending in order to avoid a re-accumulation of payment arrears. Prioritisation of public investments will be strengthened, to enhance the country's growth potential.
The authorities will take the necessary steps to improve public debt management with a view to reducing funding cost and risks and increase average maturity of public debt.
In the financial sector, authorities will continue improving the bank resolution framework and the legislation on the Deposit Guarantee Fund by amending GO 39/1996 and GEO 99/2006. To speed up the process of balance sheet cleaning, the National Bank of Romania (NBR) has clarified the provisions applicable to the write-off of loans with the Romanian Banking Association and will produce a comprehensive analysis of the asset quality in the banking sector. In order to further develop the capital market and diversify the sources of funding for banks, authorities will amend the covered bonds legislation. Preserving credit discipline and avoiding moral hazard among debtors contributes significantly to enhancing financial stability. Therefore, the government will continue refraining from adopting legislative initiatives (such as the personal insolvency law) and promoting provisions in the debt collection law, which would undermine credit discipline. Authorities will consult extensively with all relevant stakeholders, taking into account also the impact assessment finalised by the NBR, on the new provisions on abusive clauses in the law for the application of the civil procedure code, will ensure that court cases involving abusive clauses are dealt with by higher ranking courts or by a unique specialised court, and will take all other necessary measures to ensure a consistent application of these provisions. To strengthen the supervision of non-bank financial market and foster consumer protection, authorities will ensure that the legislation on the integrated non-bank financial regulator, the Financial Supervisory Authority (FSA), will be amended to comply with international good practices.
The structural reforms aim at improving market functioning, at increasing resilience to external shocks and at strengthening Romania's long-run growth potential. The structural reform agenda of this programme is a part of the broader agenda set in Romania's National Reform Programme and covered by the country-specific recommendations addressed to Romania in the context of the European Semester.
The restructuring of state-owned enterprises (SOEs), including privatisation, will be stepped up in order to reduce risks to the general government budget from accumulated arrears and operational losses, while increasing the financial viability of most of these companies' operations. Authorities will take measures to strengthen corporate governance of SOEs, including in the financial sector.
In the energy sector outstanding measures agreed under the two previous programmes will be implemented, among which the implementation of the roadmaps for the gas and electricity market liberalisation.
Improvement of the business environment and facilitating access to finance for the small and medium-size enterprises (SMEs) is another important pillar of the structural reform agenda of the programme. The programme aims at reducing administrative burden for the SMEs, facilitating their access to bank and equity capital, reducing the legal uncertainty by improving the land and property registration and supporting SMEs when going abroad. Furthermore, the programme supports the reform of the intellectual property rights framework, in particular in relation to patents, with the view to attract foreign direct investment in research and innovation activities.
In the field of labour markets, the programme supports the completion of the 2010 pension reform by equalising the pensionable age for men and women.
In addition to the above described broad areas of measures to improve the efficiency of public administration in areas critical to program implementation, the Romanian authorities will be invited to report every six months to the Economic and Financial Committee (EFC)/Economic Policy Committee (EPC) on the progress made in this area.
Monetary policy will remain geared towards price stability with a view to keeping inflation within the National Bank of Romania’s inflation target band (2.5% ± 1 percentage point).