Guillermo Tolosa, resident representative in Romania and Bulgaria of the International Monetary Fund, says the government needs to step up its reforms of state-owned companies to reduce arrears, noting that the involvement of the private sector in the management of these firms has registered an “uneven performance”.
What are the areas in which Romania’s progress has been limited under the EUR 4 billion stand-by program with the IMF and European Commission?
We should first note that major progress has been achieved. Our program with Romania is on track, and macroeconomic fundamentals strengthened further last year. Economic growth reached a post-crisis high. The current account deficit narrowed significantly in 2013. And inflation has fallen to historic lows. As a consequence, the government and private sector can now borrow at record low interest rates. It is also remarkable that for the first time Romanians now pay less for bank loans in lei than in foreign currencies. These strong macro fundamentals have also made Romania more resilient to external shocks, as proven by the country’s capacity to cope well during the recent volatilities in capital market flows.
There has also been some progress in terms of structural policies, which should put such growth on a more sustainable basis. The IPOs for the two energy companies last year and the implementation of the road map for liberalizing energy prices are important accomplishments.
Unfortunately, however, these achievements have not been matched in other areas. The end-December target for reducing the arrears of state-owned enterprises (SOEs) was missed by a substantial margin. While the authorities have taken some corrective actions to remedy this shortfall, a sustained effort is needed. This includes the aggressive restructuring of SOEs, in particular CFR Marfa, the attempt to privatize which has failed. Weak payment discipline or ability in the public sector needs to be overcome once and for all. Otherwise the public sector will hold back the prospects for sustainable, broad-based and shared economic growth.
How will Hidroelectrica’s reentry into insolvency impact the reform program in the energy sector? Aside from the energy sector, what fields are in dire need of reform?
Let me step back a bit once again on the issue of the performance of SOEs. SOE reform is a crucial element of the economic program supported by this SBA (stand-by agreement). It is not an end in itself but a vital element to achieve the government’s growth ambitions.
In particular, the energy and transportation sectors can become motors of growth. But for that to happen they require upgrading and investment. Funds will only be attracted when these companies are run professionally and more efficiently. Many of the firms still deliver poor quality services, far below EU standards. The slow speed of trains is just one example. That’s why the program seeks SOE reform in a number of ways. One is the involvement of the private sector in management. And here performance has been uneven.
We have seen too many changes on boards that coincide with changes in political leadership in line ministries. Another area is private involvement through IPOs. Here Romgaz was a major achievement and Hidroelectrica and Oltenia are set to follow.
The decision to put Hidroelectrica back into insolvency was out of the government’s control. But we expect the IPO to happen as soon as possible after the renewed exit from insolvency. For Oltenia, we expect a potential delay for technical reasons (for assessing the coal reserves) to be strictly limited in time. In order to secure continued future successes, it is important that companies that have gone through IPOs are not engaged in new plans which can represent significant deviations from the roadmap for the companies originally presented to investors.
However, there is much more to the reform program agenda of SOEs than these two companies. The government has committed to continuously reduce arrears for all SOEs. This requires tackling the companies’ underlying root problems. Many need to be restructured and made more efficient, in particular in the transport sector. Others need to receive sufficient budgetary transfers to cover their costs and avoids arrears. The SBA includes specific indicators for these targets. After a slippage regarding the SOE arrears target for end-December, there is no more room to delay difficult choices to achieve these targets in the future.
Can we conclude that Romania has scrapped the deregulation of the gas market for industrial consumers after the government passed a draft bill last month allowing big industry to negotiate deals directly with gas producers? Were you consulted on this change?
The energy regulator has so far fully implemented the agreed roadmap on energy price deregulation. The market for electricity for non-residents is already fully deregulated and important steps have also been taken for the gas market. It is important to continue this process, which will allow the full deregulation of gas prices for non-residents later this year.
Large consumers have been able to negotiate deals with gas producers in a free market, and there is no legislative change in this regard. Going forward, it is important that the government refrains from any type of interference in the free market.
What role has the IMF played in the scheme designed to cut repayment rates for close to one million Romanians? The facility, dubbed Electorata, would grant income tax credits to those enrolling in this system. Has the IMF gauged the potential impact of this scheme on banks? Will it sustain gains in domestic consumption?
This support scheme has been proposed by the government with the objective of supporting those households that have relatively low incomes and spend a large share of it on servicing their debt. Indeed, as a consequence of the crisis, households are still highly indebted. The government proposal would give certain households some breathing space and potentially increase their spending. How large the macroeconomic impact is, will depend on how many individuals and banks decide that this is an option that makes sense to them. Also, the government has committed to design the scheme in such a way that the future fiscal costs, which would be incurred as tax credits in 2016-17, would not exceed 0.1 percent of GDP.
A key positive feature of the scheme is that it is entirely voluntary. Therefore, banks do not have to make any decisions that would have a negative impact on their financial results. Against this background, and in the context of the still weak domestic demand, the scheme is not considered to go against the fundamental objectives of the IMF program.
What is holding back bank lending in Romania?
Our assessment is that the decline in credit in recent months is the result of tight supply and weak demand. Therefore efforts are needed in both areas to revive credit growth. On the supply side, steps to clean up banks’ balance sheets are important and we’re seeing some encouraging efforts. Some banks are in the process of putting NPLs (non-performing loans) up for sale after the tax treatment of such sales was finally clarified. Moreover, the National Bank of Romania is working on an action plan to reduce bad loans on banks’ balance sheets. This is a new structural benchmark under the program.
At the same time, credit constraints for small and medium-sized enterprises are being addressed through an improved and expanded lending guarantee scheme. Also, in support of households, the authorities are continuing the guarantee scheme for first-time home buyers.
And very importantly, on the demand side credit is being supported by lending rates which are at historical lows. More generally, credit demand can be fostered by further strengthening the broad policy framework to secure a stable and predictable environment for investments.
Has the lower VAT on bread and bakery products led to a reduction of the informal market in this sector? What is the IMF’s opinion on the reduction of VAT to 9 percent for other food products?
Preliminary numbers do not seem to indicate a significant reduction in evasion as a result of the measure. However, it is still too early to make a more decisive assessment.
As a general principle, we believe that consumption taxes should be uniform and differential rates across goods and services should be avoided. In order to reduce inequality it is generally more effective to use the proceeds from uniform taxes to spend on the most vulnerable.
Is the reduction of social security contributions (CAS) for employers by 5 percentage points feasible at the moment?
The overall burden on labor from social security contributions and taxation is high in Romania, in particular for those on low incomes. We therefore support any initiative that seeks to lower this burden in a fiscally neutral way. The objective of this is to make it more attractive for companies to hire more people, while at the same time making it more attractive for employees to enter the formal job market. A reduction in the social security contribution rate can be one tool to achieve this. However, it is clear that a rate cut in the order of 5 percentage points means much lower revenue for the government. So it needs to be financed in a sustainable way that does not endanger future pension and healthcare payments.
One important element that should be part of any reform is base broadening. That means contributions should shouldered by more Romanians, by reducing exemptions and getting those outside the system to become part of the system. At the same time, one needs to revisit whether those on high incomes contribute sufficiently. All of these are important and difficult choices that need to be carefully discussed with all stakeholders. We strongly encourage such a comprehensive dialogue, which would be best suited to the 2015 budget discussions.
Has the government engaged you regarding the roll out of new taxes this year?
We are not aware of new taxes to be rolled out in 2014. The government’s fiscal strategy establishes as a priority going forward to reduce certain tax rates. In order to secure this goal, it is critical that the government exercises restraint in new spending initiatives and achieves a strong implementation of revenue administration reforms.
What has the government told you about the new fuel excise of EUR 0.7 that was rolled out this month? Will it be used to finance the development of new motorways or for payments in the public sector (wages and pensions)?
There is no earmarking of taxes for specific expenditure. The last budget involved certain government spending priorities, including for investment, and a package of new measures was needed to ensure such different priorities were met. That said, it is generally considered fair that in times of greater public spending on infrastructure, taxes increase for those who are most likely to use it (consumers of fuel).
How can Romania increase its tax take, which fell by close to one percentage point to 32 percent of GDP last year?
We agree that Romania can considerably increase its tax take. A key step in this regard is a serious restructuring effort in the tax administration agency, which is nearing completion and could start to deliver results in the near term if implemented properly. A key expected outcome is that the tax authority reorients its audit efforts to where they are likely to yield better results.
The tax authority should also continue to develop its capacity to improve the oversight of some selected areas with high potential, including transfer pricing and high net worth individuals. Moreover, a project is needed to address undeclared labor and tax evasion.
It is important that further efforts are undertaken to improve voluntary compliance, by improving taxpayer services and reducing the costs of paying taxes.
The commitments under our program involve measures on most of these fronts, with the minister of public finance being fully committed to steadfast implementation.
What is your outlook for the Romanian economy this year and what could hinder its development?
We expect the economy to grow more slowly this year after the post-crisis high of 3.5 percent, but that the growth will be more broad-based and sustainable. We expect several factors to strengthen domestic demand. First, the government is committed to accelerating the absorption of EU funds. This will support public and private investment. Second, interest rates are at record lows. These are the fruits of the prudent macro policies.
Together with the efforts by banks to clean up their balance sheets, this should help alleviate weaknesses in credit demand and supply. And, finally, the economies of the eurozone are projected to grow again after last year’s recession. This should not only help exports but also help FDI and investment more generally.
A key risk going forward is that monetary policy tightening in advanced economies could trigger capital outflows as investors reassess portfolio risks and returns, which would put downward pressure on the exchange rate. Capital flows could also come under pressure if confidence wanes as the situation in Ukraine unfolds. Given the large volume of foreign-currency lending, a sharp depreciation in the exchange rate could lead to a further deterioration in bank and private sector balance sheets. Furthermore, heightened political uncertainty in the run-up to elections in 2014, in particular the presidential elections, could impact the stability of policy discussions and potentially weigh on investor and consumer sentiment.
However, Romania has buffers to withstand shocks: more than four months of projected fiscal financing needs, a flexible exchange rate, a broadly adequate level of international reserves and precautionary lines with the IMF and EC.
CV Guillermo Tolosa
July 2013-present IMF resident representative for Romania and Bulgaria
2010-2013 IMF resident representative for Armenia
Prior to this he worked in Washington, in the IMF’s Emerging Markets Department. He joined the organization in 2005 and has a PhD in Economic Sciences from the University of California, Los Angeles.
Ovidiu Posirca email@example.com