COUNCIL OPINION

of 27 March 2007

on the convergence programme of Romania, 2006-2009

(2007/C 89/06)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies(1), and in particular Article 9(1) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1) On 27 March 2007 the Council examined the convergence programme of Romania, which covers the period 2006 to 2009.

(2) Romania enjoyed strong economic growth over the past five years, but its GDP per capita (expressed in PPS) is still low at 34 % of the EU-25 average in 2005. Therefore, the scope for catching up remains ample and represents Romania's overriding challenge for the medium and long term. In 2001-2005 macroeconomic stability improved, as reflected by the sharp and sustained decline in inflation and the consolidation of public finances. The average inflation rate stood at 6,6 % in 2006.

(3) The macroeconomic scenario underlying the programme envisages that real GDP growth will decelerate progressively from a well-above potential rate of 8 % in 2006 to a still sustained 5,9 % in 2009. Assessed against currently available information, this scenario appears to be based on plausible growth assumptions. The programme's projections for inflation appear to be on the low side since they assume a sustained deceleration of credit and private consumption growth which may not materialise. Unlike the programme, the Commission's services 2006 autumn forecast projects a further widening of the external deficit in 2007 and 2008 on the basis of imports that continue to outpace exports as a result of strong private consumption and investment.

(4) For 2006, in the Commission services' autumn 2006 forecast estimated the general government deficit at 1,4 % of GDP against a target of 0,7 % of GDP set in the December 2005 pre-accession economic programme. The convergence programme estimates the deficit at 2,3 % of GDP. The slippage compared to the original target reflects significant additional expenditure, notably current spending partly due to a reallocation of unspent investment expenditures, which more than offset stronger revenue growth than expected.

(5) The main goal of the programme is to pursue fiscal consolidation so as to reach the medium-term objective of a structural deficit (in cyclically-adjusted terms net of one-off and other temporary measures) of 0,9 % of GDP in 2011, i.e. beyond the programme period. The programme targets a small reduction of the general government deficit from 2,3 % of GDP in 2006 to 2 % of GDP in 2009, after a rise to 2,7 % of GDP in 2007. The primary deficit is expected to follow a similar path and to stand at 1 % of GDP at the end of the programme period.

(6) The adjustment, which is marginal and back-loaded is done through an increase in the revenue-to-GDP ratio that is somewhat higher than the increase in the expenditure-to-GDP ratio (almost 4 percentage points compared to 3

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percentage points). On the revenue side, most of the increase comes from taxes (especially in 2007) and from ‘other revenues ’(presumably associated with EU funds inflows). The rise in the expenditure ratio stems to a large extent from a very significant increase in public investment, which is planned to more than double as a percentage of GDP due to an assumed substantial increase in the absorption of EU funds. Compared with the December 2005 pre-accession economic programme, budgetary targets are far less ambitious although the underlying growth assumptions are similar.

(7) The structural deficit (i.e. the cyclically-adjusted deficit net of one-off and other temporary measures) calculated according to the commonly agreed methodology is planned to deteriorate further from 3 % of GDP in 2006 to around 3

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% of GDP in 2007 before improving to 2

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% of GDP in 2009. As mentioned above, the medium-term objective (MTO) for the budgetary position presented in the programme is a structural deficit of 0,9 % of GDP, which the programme aims to achieve by 2011, i.e. beyond the programme period. As the MTO is more demanding than the minimum benchmark (estimated at a deficit of 1

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% of GDP), achieving it should fulfil the aim of providing a safety margin against the occurrence of an excessive deficit. The MTO adequately reflects the debt ratio and average potential output growth in the long term.

(8) The risks to the budgetary projections in the programme appear broadly balanced in 2007, but budgetary outcomes could be worse than projected in the programme thereafter. In 2007, both expenditure and revenues might be lower than planned: the former because public investment plans are unlikely to be achieved and the latter because the assumed tax intensity of economic activity appears to be favourable, explained to a certain extent by the recently implemented measures in the area of tax administration reform. From 2008 onwards, the budgetary strategy is insufficiently specified, with a volatile path for several expenditure items and an unsubstantiated tightening in 2009. Expenditure slippage in recent years through frequent budgetary amendments, the uncertainty regarding the total amount of compensation to be paid by general government to citizens for the non-return of properties nationalised during the communist regime and potential cancellations of public enterprises' unpaid liabilities towards general government point to a risk of expenditure overruns, even though the level of planned spending on investment will likely be undershot. In addition, over-budgeted resources allocated to investments might be shifted to consumption as seen in the past, with a negative impact on the quality of public spending.

(9) In view of this risk assessment, the budgetary stance in the programme seems insufficient to ensure that the MTO is achieved within the programme period, as also envisaged in the programme. In addition, it does not seem to provide a sufficient safety margin against breaching the 3 % of GDP deficit threshold with normal macroeconomic fluctuations throughout the programme period. The pace of the adjustment towards the MTO implied by the programme is insufficient and should be strengthened significantly to be in line with the Stability and Growth Pact, which specifies that the adjustment should be higher in good economic times and could be lower in bad economic times. In particular, in a context of good times, the structural improvement is marginal and fully back-loaded, with a deterioration in 2007, while the planned adjustment, notably in 2009 is not supported by measures.

(10) Government gross debt is estimated to have reached around 13 % of GDP in 2006, well below the 60 % of GDP Treaty reference value. The programme projects the debt ratio to decline by around 1 percentage point of GDP over the programme period.

(11) In the absence of the long-term projections of age-related expenditures, based on the common macroeconomic assumptions as carried out by the EPC/Commission, it is not possible to assess the impact of population ageing in Romania on a comparable and robust basis as it is currently done for the other Member States, for which the projections on this basis are available. However, a significant impact of ageing on expenditure cannot be excluded given the current demographic structure. The initial budgetary position, with a large structural deficit, is not sufficient to stabilise debt even before considering the long-term budgetary impact of ageing. Improving the structural budgetary position over the medium term would contribute to containing risks to the sustainability of public finances.

(12) The budgetary strategy in the programme is partly consistent with the broad economic policy guidelines included in the integrated guidelines for the period 2005-2008. In particular, the budgetary adjustment towards the MTO is insufficient and should be strengthened significantly over the programme period. Moreover, the fiscal strategy put forward in the programme, notably the loosening of the fiscal stance until 2007, and the limited consolidation thereafter add to aggregate demand management concerns, including those regarding the need to maintain sustained high growth, to continue to support the disinflation process and to contain the increase in the external deficit, which is estimated to have reached 10,3 % of GDP in 2006.

(13) As regards the data requirements specified in the code of conduct for stability and convergence programmes, the programme has some gaps in the required and optional data(2).

The Council considers that, in a context of strong growth prospects and a widening external deficit, the programme envisages a pro-cyclical loosening in 2007. Progress towards the MTO is insufficient and back-loaded, starting only in 2009, and is targeted to be reached only beyond the programme period. Moreover, there are risks to the achievement of the budgetary targets from 2008 onwards. In view of the above assessment, the Council invites Romania to:

(i) exploit the good times to significantly strengthen the pace of adjustment towards the MTO by aiming for more demanding budgetary targets in 2007 and subsequent years. Improving the structural budgetary position over the medium-term would contribute to containing risks to the sustainability of public finances;

(ii) control the envisaged high increase in public spending and review its composition so as to enhance the growth potential, as well as improve the planning and execution of public expenditures within a binding medium-term framework.

Comparison of key macroeconomic and budgetary projections(3)

		2005	2006	2007	2008	2009
Real GDP (% change)	CP Jan 2007	4,1	8,0	6,5	6,3	5,9
	COM Nov 2006	4,1	7,2	5,8	5,6	n.a.
	PEP Dec 2005	5,7	6,0	6,3	6,5	n.a.
HICP inflation (%)	CP Jan 2007	9,1	6,6	4,5	4,3	3,2
	COM Nov 2006	9,1	6,8	5,1	4,6	n.a.
	PEP Dec 2005	9,0	7,0	5,0	3,6	n.a.
Output gap (% of potential GDP)	CP Jan 2007(4)	0,2	2,1	2,2	1,9	1,1
	COM Nov 2006(8)	0,4	1,9	1,5	1,0	n.a.
	PEP Dec 2005	n.a.	n.a.	n.a.	n.a.	n.a.
General government balance (% of GDP)	CP Jan 2007	– 1,5	– 2,3	– 2,7	– 2,6	– 2,0
	COM Nov 2006	– 1,5	– 1,4	– 2,6	– 2,6	n.a.
	PEP Dec 2005	– 0,4	– 0,7	– 1,0	– 1,6	n.a.
Primary balance (% of GDP)	CP Jan 2007	– 0,4	– 1,2	– 1,6	– 1,5	– 1,0
	COM Nov 2006	– 0,3	– 0,4	– 1,7	– 1,7	n.a.
	PEP Dec 2005	0,8	0,4	0,0	– 0,6	n.a.
Cyclically-adjusted balance (% of GDP)	CP Jan 2007(4)	– 1,5	– 3,0	– 3,4	– 3,2	– 2,3
	COM Nov 2006	– 1,6	– 2,0	– 3,1	– 2,9	n.a.
	PEP Dec 2005	n.a.	n.a.	n.a.	n.a.	n.a.
Structural balance(5) (% of GDP)	CP Jan 2007(6)	– 1,5	– 3,0	– 3,4	– 3,2	– 2,3
	COM Nov 2006(7)	– 1,6	– 2,0	– 3,1	– 2,9	n.a.
	PEP Dec 2005	n.a.	n.a.	n.a.	n.a.	n.a.
Government gross debt (% of GDP)	CP Jan 2007	15,9	12,8	13,5	12,6	11,7
	COM Nov 2006	15,9	13,7	13,9	14,4	n.a.
	PEP Dec 2005	17,1	15,1	14,6	14,6	n.a.
Source: Convergence programme(CP); Pre-accession economic programme (PEP); Commission services' autumn 2006 economic forecasts (COM); Commission services' calculations

(1)

OJ L 209, 2.8.1997, p. 1

. Regulation as amended by Regulation (EC) No 1055/2005 (

OJ L 174, 7.7.2005, p. 1

). The documents referred to in this text can be found at the following website:

http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm

(2) In particular the data on the subcomponents of the stock-flow adjustment and the contributions to potential GDP growth by labour, capital and TFP are missing.

(3) The government accounts of Romania have not yet been officially subject to a complete quality assessment by Eurostat. Eurostat will publish and validate government balance and debt figures shortly after the data notification of 1 April 2007.

(4) Commission services calculations on the basis of the information in the programme.

(5) Cyclically-adjusted balance (as in the previous rows) excluding one-off and other temporary measures.

(6) There are no one-off and other temporary measures in the programme.

(7) There are no one-off and other temporary measures in the Commission services' autumn 2006 forecast.

(8) Based on estimated potential growth of 5,6 %, 5,7 %, 6,1 % and 6,2 % respectively in the period 2005-2008.

Source:

Convergence programme(CP); Pre-accession economic programme (PEP); Commission services' autumn 2006 economic forecasts (COM); Commission services' calculations