World Bank Romania opts for long game over quick-fix solutions

Improving tax administration and keeping a close eye on inefficiencies in public spending are the best solutions for the Romanian government in its current economic plight, advises Catalin Pauna, senior economist at the World Bank Romania country office. He adds, “the World Bank is not in Romania to finance deficits.”

Dana Ciuraru

How will the lack of economic re-launch measures and the political crisis impact the local economy?

In the short run the government should actually focus on consolidating macro stability which appears to be of some concern for the markets and international investors. It is important for the government to implement the austerity package as planned, aiming for a reduction in the budget deficit which needs to be put on a sustainable medium-term path.

At the same time, this crisis so far is a good opportunity for the government to concentrate on addressing inefficiencies in overall public spending. What we have seen in the last few years is an increase in the overall level of public spending, which has not been matched by a proportional improvement in results and improving the performance of the public sector. There is still a significant unfinished structural reform agenda that Romania needs to address. It is a good opportunity to refocus now, away from the short-term crisis-related measures, and rather to look at the structural weaknesses of the Romanian economy.

What effect will the main measures to cut expenses announced by the Romanian government have?

The government has very little option in the current context but to take bold measures to rein in expenditure. Let’s not forget that in the last few years we’ve seen a significant increase in public spending, for example, between 2005 and 2008 hikes in the monthly wage bill of about 60 percent on all terms. Also we had a significant rise in the level of pensions between 2004 and 2008. If we look back we can see an increase in public spending of around 6 percent of GDP, while, as a percentage of GDP, revenues to the budget stay constant at around 31 to 32 percent. So, if we look at these dynamics, it is easy to understand why the focus of the fiscal adjustment was placed primarily on the reduction of the current expenditures. This adjusting measure is a response to the fiscal conditions on the short term. We need to put the budget deficit on a sustainable medium-term trajectory.

On the revenue side, there is substantial hope of enhancing revenue by addressing bottlenecks in the tax administration system. On the other hand, regarding expenditure, we expect measures to be taken such as the gradual introduction of elements of performance-based budgeting, which would strengthen the relationship between the results and the allocated resources in some sectors and regarding particular expenditure categories.

How do you see the evolution of the fiscal burden in Romania?

We believe that the government’s priority should be reducing the fiscal deficit. In the short run, the measures that the government could take are those on the revenue side and on the expenditure side to primarily cut wages. In the medium term, there is also hope of raising additional revenue by improving the administration of taxes. If one compares for example tax levels and tax collection in Romania as percentages with other countries in the region, they give a clear indication that probably for a number of major taxes, compliance rates in Romania are lower than they are in other nearby countries. This indicates, in turn, that focusing more on improving tax administration, a medium-term process, could bring significant additional revenues to the budget. Obviously, in a context of renewed economic growth, this could open up the possibility of revising some of the tax increase decisions motivated by the short-term fiscal constraints faced by the government.

At the same time, one cannot ignore that labor tax in Romania remains one of the highest rates in Europe. On the expenditure side the inefficiency in public spending needs to be addressed. This would make room for additional intake at the main tax level. This is what in fact happened in some countries in the region like Bulgaria, where we saw a gradual decline in the level of some taxes, like corporate and income tax, concomitant with an increase in the budget revenue.

Government officials stated recently that Romania needs another agreement with the IMF or another international financial institution. Is Romania in a position to support such a financial burden?

Obviously when you have a large fiscal deficit you have to finance it and when you have short-term maturing debt obviously you need to roll this over or finance this as well, so, clearly, any country in this situation would like to borrow as cheaply as possible. Working with the IMF and the European Commission is probably one of the best financing options that the government has available at this stage. Clearly the scope of engaging the international financial institution stretches well beyond the financing needs of the short-term fiscal gap.

These institutions work with the government to support the reform agenda which focuses on macro consolidation. There is the longer-term agenda through which the government aims at addressing the root causes of the existing vulnerabilities. So the World Bank is not in Romania to finance deficits, it’s primarily in Romania to support the bold long-term agenda.

Is Romania still interesting to investors or are we seeing foreign companies exiting the market because of the unpredictability of the local situation?

If one is looking at, for example, the FDI inflows in Romania in the last seven-eight years, Romania was actually an important beneficiary of foreign investment, somewhere in the neighborhood of five-six percent of GDP, which is high by any standards. So if an investor

takes a long-term perspective decision about where to invest, then maybe Romania has many things to offer. It has a relatively well educated labor force. It is a member of the European Union, hence the proximity to the markets. Of course, the uncertainties in the short term,

those related to the stability of the macroeconomic environment, could have a negative impact on the propensity of investors to come into the

country.

dana.ciuraru@business-review.ro

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