Romania The challenges to long run fiscal sustainability

Romania, along with many other countries in the European Union, faces daunting fiscal challenges. Fiscal balances deteriorated sharply following the global economic crisis, forcing Romania to implement a fiscal consolidation that was one of the largest in the European Union, but which may not be sustainable without a recovery of economic growth. Although the ratio of public debt to gross domestic product is still relatively modest, at around 35 percent, long-term fiscal solvency is threatened by the costs of funding the public pension system in the face of adverse demographic shifts over the next 50 years. Because of widespread tax evasion, the tax system in Romania is one of the least efficient in the European Union. Tax reforms that can reduce the amount of tax lost to evasion and fraud could make a major contribution to enhancing fiscal sustainability.

Fiscal sustainability has emerged as a key policy issue throughout Europe in recent years, in part because the fiscal positions of many countries on the continent were badly affected by the global financial and economic crisis and also because of an increasing public recognition of the magnitude of the long-term fiscal costs of demographic change, notably aging populations. Several of the new member states of the European Union, including Romania, face major challenges to ensure fiscal sustainability. The sustainability of Romania’s public finances deteriorated sharply in the years leading up to the global economic crisis. The global economic crisis triggered a severe recession in Romania, exposing the fragility of public finances. To bring the fiscal deficit back into line with the targets in the EU’s Stability and Growth Pact, the government implemented a draconian fiscal consolidation in 2010, but it still faces huge long-term fiscal costs as a result of population aging. Long-term fiscal sustainability, along with meeting the fiscal criteria required for membership of the Eurozone monetary union, is also threatened by the poor management of public expenditures.

Maintaining fiscal sustainability should be a priority for policy makers. An unsustainable fiscal position threatens both macroeconomic stability and the financial capacity of the state to deliver essential goods and services to citizens. Moreover, if fiscal positions are perceived to be unsustainable over the long term, the reaction of the markets on which governments finance their borrowing requirements could trigger a fiscal crisis much sooner than might be expected by fiscal planners.

Fiscal sustainability is essentially a forward looking macroeconomic concept which is related to the solvency of government. It is closely linked to the future course of the fiscal deficit and the evolution of public debt and to the government’s capacity to mobilize finance for the deficit and/or to refinance its debt. Alvarado et al. (2004) define a sustainable fiscal policy as a set of fiscal policies which will not lead to the government having, at some point in the future, to default on its debt or to monetize its debt, or be forced to undertake a major fiscal retrenchment to avoid default or monetization.

A starting point for analyzing fiscal sustainability is the current levels and medium-term projections of general government fiscal balances and public debt. It is relatively straightforward to determine the impact of such fiscal balances, if extrapolated forward into the future and combined with some basic macroeconomic projections, on the evolution of public debt levels, with debt sustainability being defined as a situation where public debt as a ratio of GDP is stable or falling and/or does not exceed some critical threshold. Section 2 of this paper examines the general government fiscal balances and public debt levels in Romania and the medium-term projections of these variables. The general government fiscal data include the local governments.

The data captured in the general government budget, however, often provide an incomplete and hence misleading picture of the sustainability of public finances over the long term. This is starkly illustrated by a comparison of current public debt levels with calculations of the long-term net worth of the government in Romania, taking into account the long-term costs of aging. Romania’s outstanding public debt amounted to 32 percent of GDP in 2010, a relatively moderate level. In contrast, Velculescu (2010) estimates the inter-temporal net worth of the Romanian government at negative 252 percent of GDP, based on a finite horizon approach and negative 1,097 percent of GDP based on an infinite horizon approach.

Risks to fiscal sustainability may emanate from activities of the public sector, which are not currently part of the general government budget, but which might eventually impose fiscal liabilities on the budget. These could include contingent liabilities of government, such as loan guarantees, or the quasi fiscal deficits (QFDs) of state owned enterprises. The QFDs of the state owned enterprises are discussed in Section 3.

World Bank. Author: Canagarajah, Sudharshan; Brownbridge, Martin ; Paliu, Anca ; Dumitru, Ionut. Document Date: 2012/01/01. Document Type: Policy Research Working Paper.Report Number: WPS5927.

The challenges to long run fiscal sustainability in Romania

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Is the Recovery Sustainable?

Strategic Analysis.December 2011.Levy Economics Institute of Bard College. Fiscal austerity is now a worldwide phenomenon, and the global growth slowdown is highly unfavorable for policymakers at the national level. According to our Macro Modeling Team's baseline forecast, fears of prolonged stagnation and a moribund employment market are well justified. Assuming no change in the value of the dollar or interest rates, and deficit levels consistent with the Congressional Budget Office’s most recent “no-change” scenario, growth will remain very weak through 2016 and unemployment will exceed 9 percent.

In an alternate scenario, the authors simulate the effect of new austerity measures that are commensurate with the implementation of large federal budget cuts. Here, growth falls to 0.06 percent in the second quarter of 2014 before leveling off at approximately 1 percent and unemployment rises to 10.7 percent by the end of 2016. In their fiscal stimulus scenario, real GDP growth increases very quickly, unemployment declines to 7.2 percent, and the US current account balance reaches 1.9 percent by the end of 2016—with a debt-to-GDP ratio that, at 97.4 percent, is only slightly higher than in the baseline scenario.

An export-led growth strategy may accomplish little more than drawing a small number of scarce customers away from other exporting nations, and the authors expect no net contribution to aggregate demand growth from the financial sector. A further fiscal stimulus is clearly in order, they say, but an ill-timed round of fiscal austerity could result in a perilous situation for Washington.

Strategic Analysis.December 2011.Levy Economics Institute of Bard College. DIMITRI B. PAPADIMITRIOU, GREG HANNSGEN, AND GENNARO ZEZZA.

Is the Recovery Sustainable?

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Honduras.Fiscal Emergency Recovery Development Policy Credit Program

One of the Honduran administration’s top objectives is to foster high economic growth. Putting the economy on a rapid and sustainable growth path will not be easy, but it is feasible. Action will be required on five fronts. First and foremost, a more conducive macroeconomic framework is necessary; in particular, redressing the large imbalances in Central Government finances and unresolved structural weaknesses in public pension funds and public sector enterprises. Second, an integrated citizen security strategy is necessary to tackle the increasing levels of crime and violence that are undermining the country’s growth potential and investment climate. Third, investments in infrastructures are needed to promote the country’s regional development. Fourth, poor governance negatively affects return rates of investment opportunities in Honduras. Finally, low levels of human capital are an important growth constraint. This operation will focus on addressing the first two areas; the rest are being supported by other Bank operations and activities.

2. The Government launched fiscal consolidation efforts in 2010 and has begun tackling the remaining risks to macroeconomic stability and unresolved structural weaknesses in public pension funds and public sector enterprises. To this end, the Government has already introduced measures to close the actuarial deficits of the main public pension institutes—Instituto Nacional de Previsión del Magisterio (INPREMA), which serves the private sector and public sector teachers, and Instituto Nacional de Jubilación y Pensiones de los Empleados Públicos (INJUPEMP), which covers Central Government civil servants.

Similarly, the Government has introduced measures to contain the wage bill and is implementing a strategy to strengthen tax administration.

3. President Lobo’s administration has begun to make significant efforts to fight crime and violence and promote citizen security; however, these efforts will require substantial implementation support in order to be sustained and to have a robust development impact over time. The Government has approved the National Citizen Security and Co-existence Policy 2011-2022, which provides a comprehensive and long-term approach to this challenge, with crime prevention as one of its main pillars. In addition, the Government has mandated the Security, Defense, and Governance Cabinet (Gabinete de Seguridad, Defensa y Gobernabilidad) to provide the intra-governmental coordination which is required to implement the policy. Moreover, Congress has approved legal reforms to secure new resources to finance activities to foster security, including those addressed in the citizen security policy framework.

4. This document describes a proposed First Programmatic Reducing Vulnerabilities For Growth Development Policy Credit (DPC) in the amount of SDR 55.1 million for the Republic of Honduras. The programmatic series, which includes one subsequent loan, is designed to assist the Government in strengthening fiscal management and in implementing an integrated citizen security policy. Specifically, the operation supports four areas that are central to the reform program: (i) tax administration, focused on improving taxpayer compliance; (ii) civil service reform, focused on the rationalization of the public
wage bill by delinking teachers’ salary adjustments from those reflected in the private sector’s minimum wage; (iii) pension reform, designed to lessen contingent fiscal vulnerabilities by reducing the public pension institutions’ actuarial deficits, and (iv) citizen security reform, focused on strengthening institutional coordination mechanisms and programs needed for an integrated violence prevention strategy . The reforms supported by this operation are expected to have a positive impact on poverty and inequality (see section VI).

5. The proposed operation is envisaged in the new Country Partnership Strategy covering the period FY2012-2014 (to be presented jointly with this operation to the Board of Executive Directors) and is closely aligned with other Bank operations. For example, the Improving Public Sector Performance Technical Assistance Loan (P110050, currently under preparation and expected to accompany this operation) provides support to strengthen public sector human resource management. In addition, a Japan Social Development Fund (JSDF) for Employment Generation in Poor Urban Neighborhoods will complement this operation.

World Bank. Document Date:  2011/11/03.Document Type:  Program Document.Report Number:55656.Volume No: 1 of 1

Honduras - Fiscal Emergency Recovery Development Policy Credit Program

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Statement by an IMF Mission to Paraguay

Press Release No. 11/419. November 16, 2011. An International Monetary Fund (IMF) mission visited Paraguay during November 9–15, 2011 for discussions with government officials and the private sector, as part of the IMF’s regular consultations with its member countries. At the end of the visit, mission chief Lisandro Ábrego issued the following statement today in Asunción:“In recent years, Paraguay has strengthened its institutional framework and implemented generally prudent fiscal and monetary policies.

These policies have led to positive growth and employment outcomes and helped reduce inflation. Going forward, it is important to keep improving policy formulation and implementation, and strengthening Paraguay’s institutions, as once this hard-won policy credibility is lost, it is not easily recovered.

“While growth has normalized after a sharp rebound in 2010, negative shocks have had an impact this year. After expanding by 15 percent in 2010, growth slowed to 4.5 percent in the first half of the year, reflecting mainly the return of agricultural growth to more normal levels, cement shortfalls, and problems with accessing key beef export markets. In the same vein, inflation also started to slow down, in line with less expansionary monetary conditions, and assisted by lower commodity prices and the appreciation of the guaraní. Staff now expects the economy to grow by 4.5 percent in 2011 and by a similar rate in 2012. Regarding prices, we now expect inflation to end 2011 at 5.5 percent, and rise to slightly above 6 percent by end-2012 as a strong fiscal stimulus takes effect and temporary factors that helped reduce inflation this year are reversed.

“Ongoing developments in fiscal policy are of particular concern. Efforts to expand revenues needed to address important deficiencies in infrastructure and social services have stalled. At the same time, plans to place the increase in Itaipú revenues in a special fund are being rejected in congress. Instead, an initiative to sharply increase public sector wages in 2012 (by more than 2 percentage points of Gross Domestic Product ) could be approved. This would give rise to a significant fiscal impulse next year and would also crowd out critical public sector investment.

The mission is also concerned about proposals to essentially eliminate the government's room for maneuver in the formulation of the Financing Plan. In 2011, the Ministry of Finance did an important effort to achieve a less expansionary fiscal policy and continue strengthening the public finances, and the central government is expected to record a small surplus. For 2012, however, the mission projects a significant deterioration in the public finances, with an important deficit (the first deficit since 2003) and a fiscal expansion of more than 2 percent of GDP. The mission considers that the fiscal policy stance should be neutral in 2012 to help contain inflation, which affects disproportionately more the poorest segments of the population, and improve the external sector accounts.

“The Central Bank of Paraguay (BCP) has responded appropriately to contain the surge in inflation. Since the turn in the cycle, reserve requirements have been increased and the policy rate has been raised by 800 basis points as of August—turning it positive in real terms. This has helped reduce domestic demand growth and inflationary pressures. However, the recent softening in inflation owes also to a significant degree to exogenous temporary factors (e.g., lower meat prices) and other factors that are in the process of being reversed (appreciation of the guaraní). Meanwhile, the growth of credit (particularly in dollars) and domestic demand remains high, although it has been moderating. With fiscal policy set to provide a strong positive impulse in 2012, and in the context of the current uncertain global environment, it would be appropriate to set monetary policy in a “wait and see” mode, as it would allow for clearer signals on the future direction of inflation to emerge.

“The authorities should move quickly to fill existing vacancies on the BCP Board of Directors and recapitalize the central bank. With the two open positions and the term of one current director expiring in April 2012, core operations of the central bank may soon be compromised. The recapitalization of the central bank is also a key ingredient to further enhance its independence and ability to implement monetary policy effectively. Both measures are critical to facilitate the central bank’s move to an inflation targeting regime.

“Overall, the banking system continues to remain sound and profitable. We welcome the authorities strengthening of financial system buffers, including through higher loan provisions and higher capital requirements. There is, however, scope to continue strengthening the financial sector, including through measures targeting currency mismatches by unhedged borrowers and the high growth of consumer credit. In the cooperative sector, the mission also welcomes progress regarding plans for strengthening regulation and supervision, the creation of a financial safety net for the sector, and the development of risk based indicators. Swift implementation of these initiatives will benefit the sector and reinforce the strength of the overall financial system.

“Finally, the IMF mission would like to thank the authorities and private sector representatives of Paraguay for a very open and stimulating dialogue and for their cooperation and warm hospitality.”

The Eurozone Crisis: How Banks and Sovereigns Came to be Joined at the Hip

We use the rise and dispersion of sovereign spreads to tell the story of the emergence and escalation of financial tensions within the eurozone. This process evolved through three stages. Following the onset of the Subprime crisis in July 2007, spreads rose but mainly due to common global factors. The rescue of Bear Stearns in March 2008 marked the start of a distinctively European banking crisis.

During this key phase, sovereign spreads tended to rise with the growing demand for support by weakening domestic financial sectors, especially in countries with lower growth prospects and higher debt burdens.

As the constraint of continued fiscal commitments became clearer, and coinciding with the nationalization of Anglo Irish in January 2009, the separation between the sovereign and the financial sector disappeared.

Author/Editor: Mody,Ashoka;Sandri,Damiano.Authorized for Distribution: November 01, 2011.Series:Working Paper No. 11/269
This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

The Eurozone Crisis: How Banks and Sovereigns Came to be Joined at the Hip

The Design of Fiscal Adjustment Strategies in Botswana, Lesotho, Namibia, and Swaziland

Botswana, Lesotho, Namibia, and Swaziland face the serious challenge of adjusting not only to lower Southern Africa Customs Union (SACU) transfers because of the global economic crisis, but also to a potential further decline over the medium term. This paper assesses options for the design of the needed fiscal consolidation. The choice among these options should be driven by (i) the impact on growth and (ii) the specificities of each country.

Overall, a focus on government consumption cuts appears to minimize the negative impact on growth, and would be appropriate given the relatively large size of the public sector in each country.

IMF.Author/Editor:Basdevant, Olivier;Benicio, Dalmacio;Mircheva,Borislava;Mongardini,Joannes;Verdier,Geneviève;Yang, Susan;Zanna,Luis-Felipe. Authorized for Distribution: November 01, 2011.Series: Working Paper No. 11/266
This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

The Design of Fiscal Adjustment Strategies in Botswana, Lesotho, Namibia, and Swaziland

IMF Executive Board Completes Fifth Review Under Stand-By Arrangement with Angola and Approves US$134.8 Million Disbursement

The Executive Board of the International Monetary Fund (IMF) today completed the fifth review of Angola’s economic performance under a program supported by the Stand-By Arrangement. The Board’s decision enables the immediate disbursement of an amount equal to SDR 85.9 million (about US$134.8 million), bringing total disbursements under the arrangement with Angola to an amount equal to SDR 773.01 million (about US$ 1.21 billion).

In completing the program review, the Executive Board approved a waiver of applicability for the end-September 2011 performance criteria. The Executive Board also approved the modification of the end-September 2011 quantitative performance criteria on reserve accumulation, BNA net domestic assets and net credit of the banking system to the government.

The 27-month Stand-by Arrangement for Angola in the amount of SDR 858.9 million (300 percent of quota) was originally approved by the IMF Executive Board on November 23, 2009 (see Press Release No. 09/425).

At the conclusion of the Executive Board's discussion on Angola, Mr. Naoyuki Shinohara, Deputy Managing Director and Acting Chair, stated:

“The Angolan authorities should be commended for strong performance under the Fund-supported stabilization and reform program. Spending has been contained, and budget execution enhanced. The sustained fiscal adjustment, helped by higher oil prices, has fostered reserve accumulation, a stable exchange rate, and declining inflation. The authorities have completed the settlement of the large 2008/09 stock of payment arrears, a major objective under the program.

“Public financial management and transparency continue to be key priorities going forward. The government has stepped up its monitoring of oil revenue transfers to the budget, and work is ongoing to reduce the large unexplained residual in the fiscal accounts and to reduce quasi-fiscal operations by the state oil company. The government is producing quarterly reports on budget execution, and the state-owned oil companies publishing audited financial statements. The central bank is stepping up its internal control system and has completed its 2010 audited financial statements. A medium-term fiscal framework will help shield priority spending from oil-price fluctuations.

“Substantial progress has been made on financial sector development. The success of the de-dollarization program will depend on the sustained implementation of sound macroeconomic policies, continued progress in reducing inflation, and efforts to develop capital markets and saving instruments.

“The Executive Board also reviewed a report from the Managing Director concerning an upward revision of end-2009 oil revenue data that had led to a noncomplying purchase in 2010 and a breach of obligations under Article VIII, Section 5, of the IMF’s Articles of Agreement. In light of the necessary corrective actions taken by the authorities, and strengthened efforts to ensure the timely transfer of oil revenue to the budget, the Executive Board agreed to grant a waiver for the nonobservance of the condition on the accuracy of the information reported by Angola, and that no further action is required,” Mr. Shinohara added.

Press Release No. 11/405
November 9, 2011

World Bank: Mexico Fiscal Risk Management Development Policy Loan

Institutional and structural reforms associated with Mexico’s fiscal risk management strategy were fundamental in mitigating the impact of the 2008/09 global financial crisis on public accounts. The Government’s integrated fiscal mitigation framework has evolved over the years and incorporates mechanisms to retain, mitigate and transfer risk related to contingent as well as direct government liabilities. Since 2006, fiscal policy has been guided by the balanced budget rule and medium-term budgetary framework imbedded in the Fiscal Responsibility Law (FRL).

The FRL institutionalized Government efforts to contain fiscal deficits and stabilize debt levels, while supporting accountability and transparency in the annual budget process. In addition to the establishment of a balanced budget rule, the law also introduced a formula for calculating oil prices in budget projections, and established excess oil-revenue stabilization funds.

The saving of revenue in the stabilization funds, Mexico’s oil hedging program and the allowance of temporary deficits provided the authorities with some space to conduct countercyclical fiscal policy without jeopardizing long-term sustainability following the 2008/09 sharp contraction and drop in oil price. However, the protracted impact of the crisis on fiscal accounts worldwide and the impact of the European debt crisis underscore the importance of designing effective risk management strategies in order to minimize the impact of fiscal shocks.

As the global cyclical recovery wanes, economic growth in Mexico is converging toward the country’s medium term potential growth rate. Economic growth has moderated to about 3.8 percent in 2011, after posting an annual rate of growth of 3.9 percent during the first half of the year. Downside risks to growth, associated with a slowdown in U.S. growth and the ongoing problems in Europe, are significant. Despite the U.S. slowdown, external demand will remain buoyed by growth in U.S. industrial production and improved Mexican external competitiveness. Domestic demand will remain expansionary and driven by labor market improvements, credit growth and infrastructure investment. A more moderate global and domestic economic outlook will restrain price pressures.

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