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EUROPEAN COMMISSION DIRECTORATE GENERAL ECONOMIC AND FINANCIAL AFFAIRS Brussels, 20 May 2020 Assessment of the 2020 Convergence Programme for Romania (Note prepared by DG ECFIN staff) 1  CONTENTS EXECUTIVE SUMMARY ................................................................................................. 3 1. INTRODUCTION ...................................................................................................... 4 2. MACROECONOMIC DEVELOPMENTS .............................................................. 4 3. RECENT AND PLANNED BUDGETARY DEVELOPMENTS ........................... 7 3.1. DEFICIT AND DEBT DEVELOPMENTS AND TARGETS ................................ 7 3.2. MEASURES UNDERPINNING THE PROGRAMME.......................................... 9 3.3. RISK ASSESSMENT ............................................................................................. 11 4. COMPLIANCE WITH THE PROVISIONS OF THE STABILITY AND GROWTH PACT ..................................................................................................... 11 4.1. Compliance with the deficit criterion .......................................................... 11 2 EXECUTIVE SUMMARY  On 6 April 2020, the Commission provided guidelines to the Economic and Financial Committee on how the format and content of the 2020 Stability and Convergence Programmes can be streamlined in light of the exceptional circumstances related to the Covid-19 pandemic. This assessment takes into account the severe constraints that Member States faced in providing the information usually required in their Programmes. The assessment focuses on the near term in light of the high uncertainty attached to the projections.  The Programme estimates a 1.9% contraction of real GDP in 2020 and a return to close to potential growth over the medium term, while not providing an estimate for 2021. The Commission 2020 spring forecast expects a more significant contraction of 6% in 2020, followed by a 4.2% increase in 2021. The difference stems from more optimistic assumptions regarding the negative impact of the lockdown in the Programme.  The Programme projects the general government deficit to increase to 6.7% of GDP in 2020, from 4.3% of GDP in 2019. The Commission 2020 spring forecast projects a general government deficit of 9.2% of GDP in 2020. The difference stems, in particular, from the difference in underlying macroeconomic projections and from the fact that a relative moderation of some current spending items in the Programme is not fully supported by enacted measures.  The Programme includes expenditure measures taken in response to the COVID-19 outbreak of a cumulative budgetary impact of 1.2% of GDP in 2020, notably for technical unemployment and related benefits, out of which 0.4% of GDP financed by additional EU transfers. Moreover, the authorities adopted measures to support the liquidity of companies and individuals: in the field of taxation, a loan guarantee for SMEs and a possibility of bank loan deferrals.  The Programme also incorporates significant pension increases beyond the standard pension indexation mechanism, adopted in summer 2019. They are set to significantly increase public spending and thus fiscal deficits in 2020 and beyond.  The macroeconomic and fiscal outlook are affected by high uncertainty due to the outbreak of the COVID-19 pandemic. Moreover, further downward risks to the budget targets stem from the underlying unrealistic macroeconomic projections and the possible overestimation of some revenues and underestimation of some current expenditure items. 3 1. INTRODUCTION This document assesses the economic and budgetary projections contained in the 2020 Convergence Programme of Romania for 20201 (hereafter called the Programme), which was submitted on 14 May 2020, after the deadline of 30 April established by the Regulation. The government approved the Programme on 14 May 2020. Romania is currently subject to the corrective arm of the SGP. The Council opened the Excessive Deficit Procedure for Romania on 3 April 2020. The country is recommended to correct the excessive deficit by 2022. On 20 March 2020, the Commission adopted a Communication on the activation of the general escape clause of the Stability and Growth Pact. The clause, as set out in Articles 5(1), 6(3), 9(1) and 10(3) of Regulation (EC) 1466/97 and Articles 3(5) and 5(2) of Regulation (EC) 1467/97, facilitates the coordination of budgetary policies in times of severe economic downturn. In its Communication, the Commission shared with the Council its view that, given the expected severe economic downturn resulting from the COVID-19 outbreak, the current conditions permit the activation of the clause. On 23 March 2020, the Ministers of Finance of the Member States agreed with the assessment of the Commission. The activation of the general escape clause allows for a temporary departure from the adjustment path towards the medium-term budgetary objective, provided that this does not endanger fiscal sustainability in the medium term. For the corrective arm, the Council may also decide, on a recommendation from the Commission, to adopt a revised fiscal trajectory. The general escape clause does not suspend the procedures of the Stability and Growth Pact. It allows Member States to depart from the budgetary requirements that would normally apply while enabling the Commission and the Council to undertake the necessary policy coordination measures within the framework of the Pact. Romania is among those Member States who have triggered national escape clauses to suspend budgetary constraints set by their national fiscal rules, as part of the effort to accommodate the budgetary implications of the outbreak. 2. MACROECONOMIC DEVELOPMENTS In 2019, economic activity expanded by 4.1% supported by private consumption and a rebound in investment. For 2020, the Programme's macroeconomic scenario assumes a negative economic impact of the coronavirus crisis lasting 4 months (from March until June), followed by a partial recovery over July-September that builds up in the last quarter of 2020. This results in a projected 1.9% contraction of real GDP in 2020. This is a downward revision of projected GDP growth by 7.6 percentage points compared to the 2019 Convergence Programme. For 2021, the Programme does not give an estimate but projects growth to return close to potential, at around 3-4%, over the medium term. 1 The Convergence Programme contains only short-term budgetary projections, in line with the guidelines for a streamlined format of the 2020 Stability and Convergence Programmes in light of the COVID-19 outbreak, provided by the Commission services on 6 April 2020. 4 The manufacturing and services sectors are expected to make sizeable negative contributions to growth. Private consumption, which expanded by 5.9% in 2019 in real terms, is expected to moderately decline, by 0.7% in 2020. After very strong growth in 2019, investment is projected to decrease by 2.6% in 2020 amid heightened uncertainty. Exports are forecast to contract somewhat more than imports. The slight reduction in the deficit of the trade balance is expected to result in a small correction of the current account deficit. The measures adopted by the government to support household income as well as businesses’ liquidity, notably through loans guarantees for SMEs, are expected to limit the economic downturn and support the recovery. On the other hand, any delays in the exit from the lockdown beyond June are expected to have a more pronounced impact on economic activity. The state of emergency was declared in Romania on 16 March for a period of 30 days and was subsequently extended by another month. The movement of the population was substantially restricted, border and travel restrictions were introduced, non-essential shops, bars, restaurants were closed. Teleworking arrangements were made operational for private companies and part of the public sector. The real GDP decline projected in the Programme for 2020 is significantly lower than the contraction of 6% projected in the Commission 2020 spring forecast. This is mostly due to more optimistic assumptions regarding the negative impact of the lockdown in the Programme. The inflation projections for 2020 in the Programme are somewhat higher than in the Commission's spring 2020 forecast. The economic growth assumptions in the Programme are subject to a high degree of uncertainty. Downward risks to the macroeconomic outlook stem from a possible second wave of infections towards the end of 2020, a delayed restart of economic activity as well as the small fiscal buffers available to support economic activity over a longer period of time. In its opinion on the 2020 budget amendment of 17 April 2020, the Romanian Fiscal Council concluded that the 1.9% decline in real GDP expected for 2020 was very optimistic. According to the Fiscal Council, two additional macroeconomic scenarios should be considered for 2020: one assuming a contraction of real GDP of 4% to 6% and a more pessimistic scenario assuming a GDP contraction of 8% to 9%. 5  Table 1: Comparison of macroeconomic developments and forecasts 2019 2020 2021 COM CP COM CP COM CP Real GDP (% change) 4.1 4.1 -6.0 -1.9 4.2 n.a. Private consumption (% change) 5.9 5.9 -6.2 -0.7 4.9 n.a. Gross fixed capital formation (% change) 18.2 18.2 -15.0 -2.6 5.0 n.a. Exports of goods and services (% change) 4.6 4.6 -12.8 -6.7 9.9 n.a. Imports of goods and services (% change) 8.0 8.0 -14.4 -5.6 9.8 n.a. Contributions to real GDP growth: - Final domestic demand 8.7 8.6 -6.9 -0.6 4.4 n.a. - Change in inventories -2.9 -2.9 -0.3 -1.0 0.0 n.a. - Net exports -1.7 -1.7 1.2 -0.3 -0.3 n.a. Output gap 1 0.5 0.6 -8.0 -4.4 -6.6 n.a. Employment (% change) -0.1 n.a. -2.5 n.a. 0.6 n.a. Unemployment rate (%) 3.9 n.a. 6.5 n.a. 5.4 n.a. Labour productivity (% change) 4.1 n.a. -3.6 n.a. 3.5 n.a. HICP inflation (%) 3.9 3.9 2.5 2.9 3.1 n.a. GDP deflator (% change) 6.9 6.9 2.3 4.1 2.5 n.a. Comp. of employees (per head, % change) 8.9 n.a. 2.6 n.a. 4.8 n.a. Net lending/borrowing vis-à-vis the rest of the -3.1 n.a -1.7 n.a -1.7 n.a. world (% of GDP) Note: 1 In % of potential GDP, with potential GDP growth recalculated by Commission services on the basis of the programme scenario using the commonly agreed methodology. Source : Commission 2020 spring forecast (COM); Convergence Programme (CP). 6 3. RECENT AND PLANNED BUDGETARY DEVELOPMENTS 3.1. DEFICIT AND DEBT DEVELOPMENTS AND TARGETS In 2019, the general government deficit rose to 4.3% of GDP from 2.9% in 2018. The increase was driven by higher current expenditure, in particular on public wages, intermediate consumption and social benefits. Additionally, public investment rebounded from the very low levels of previous years. The 2019 deficit outcome was much higher than the 2.8% of GDP targeted for 2019 in the 2019 Convergence Programme. The difference is driven by the revenue side, in particular by lower revenue from social contributions than originally planned. For 2020, Romania targets a general government deficit of 6.7% of GDP. Revenues are projected to decrease by 1.0 percentage point of GDP compared to 2019, while expenditures are projected to increase by 3.5 percentage points of GDP including due to the cost of automatic stabilisers. The Programme includes expenditure measures taken in response to the COVID-19 outbreak of a cumulative budgetary impact of 1.2% of GDP, notably for subsidies (technical unemployment), out of which 0.4% of GDP are to be financed by additional EU transfers (according to the information in the 2020 budget amendment of 17 April 2020). Moreover, social transfers are set to increase considerably (by 1.4 percentage points of GDP), due to the significant increases to old-age pensions enacted before the COVID-19 crisis. The measures are described in detail in section 3.2 below. The 2020 deficit target of 6.7% of GDP is lower than the 9.2% of GDP projected in the Commission forecast. The difference stems, in particular, from a difference in underlying macroeconomic projections and the fact that a relative moderation of some current spending items is not fully supported by enacted measures. The general government debt is planned in the Programme to increase from 35.2% of GDP in 2019 to 40.9% of GDP in 2020, driven by government deficit and nominal GDP developments. 2 2 In light of the activation of the general escape clause, the measures taken in response to the coronavirus outbreak in 2020 are not treated as one-off and are thus not excluded from the estimation of the structural budget balance. 7  Table 2: General government budgetary position 2019 2020 2021 (% of GDP) COM COM CP COM CP Revenue 31.7 32.3 32.7 32.2 n.a. of which: - Taxes on production and imports 10.6 10.2 10.5 10.3 n.a. - Current taxes on income, wealth, etc. 4.8 4.6 4.8 4.7 n.a. - Social contributions 11.3 11.7 11.5 11.6 n.a. - Other (residual) 5.0 5.8 5.9 5.6 n.a. Expenditure 36.0 41.5 39.5 43.5 n.a. of which: - Primary expenditure 34.8 40.0 38.1 41.8 n.a. of which: Compensation of employees+Intermediate consumption 16.6 18.3 17.2 18.0 n.a. Compensation of employees 11.2 12.5 11.6 12.2 n.a. Intermediate consumption 5.4 5.9 5.6 5.8 n.a. Social payments 11.8 14.4 13.2 16.8 n.a. Subsidies 0.4 1.2 1.2 0.4 n.a. Gross fixed capital formation 3.4 3.3 3.7 4.0 n.a. Other (residual) 2.5 2.9 2.7 2.5 n.a. - Interest expenditure 1.2 1.5 1.4 1.7 n.a. General government balance (GGB) -4.3 -9.2 -6.7 -11.4 n.a. Primary balance -3.1 -7.8 -5.4 -9.6 n.a. One-off and other temporary measures -0.1 0.0 0.0 0.0 n.a. GGB excl. one-offs -4.2 -9.2 -6.7 -11.4 n.a. 1 Output gap 0.5 -8.0 -4.4 -6.6 n.a. 1 Cyclically-adjusted balance -4.4 -6.7 -5.2 -9.2 n.a. 2 Structural balance -4.3 -6.7 -5.2 -9.2 n.a. 2 Structural primary balance -3