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Romanian fiscal policies: do they fight or exacerbate the crisis?

Introduction

It is now undisputed that the world faces the most serious economic downturn since the Great Depression. There are more and more voices calling for action against the financial crisis, and expectations on governments worldwide grow accordingly. In the past months several fiscal measures and stimuli packages were proposed to help the ailing economies. Most notably, the IMF issued a note proposing a coherent fiscal stimulus package, to tackle in an effective manner the economic and financial crisis. However, the extent to which these proposed measures could possibly be applied in Romania remains uncertain, mainly because of the poor institutional setup of the public sector overall (systemic inefficiencies, governance and transparency issues), but also the costly commitments made in the elections year 2008, which have recurrent effects (wage increases, improperly targeted social spending).

The following paper examines the applicability of an effective fiscal package in Romania, and suggests improvements in the existing institutions to enhance the Government's control over its own instruments--budget revenues and public spending. Contrary to the widespread, more pessimistic views, we believe that the crisis is an opportunity for reform: as revenues drop in proportion to the economic downturn, a wise Government would have the best incentives to reduce inefficient spending and understand the importance of a longer term vision. Or--luckily, this is our case--it would be forced to do so by foreign aid conditionality. However, there is a downside risk as well: since 2009 is again an elections year, the pattern of wasteful spending to attract votes could be maintained, while cuts are operated in the most important areas: the investments in complex programs and infrastructure. The following paragraphs describe the general recommendations for the use of fiscal instruments against the crisis. What can fiscal policies do against the crisis?

The IMF suggested approach (1)

The IMF suggests a policy package to address both the financial crisis and the fall in aggregate demand simultaneously. Such a two-pronged policy is needed to address issues which are complementary in nature: on one hand, the recapitalization of banks would improve credit flows, and aggregate demand would be further boosted by targeted measures such as support for the housing market. IMF recommends that the fiscal stimulus be timely, large, durable as to last over the period of recession, with diversified measures, and, maybe most importantly, sustainable as to avoid excessive debt or other short-term catastrophic effects. The fiscal measures which are most likely to lead to good results consist of increased spending (preferred to tax cuts), and at the same time spending instruments need to be diversified to limit the risk that fiscal multipliers are not estimated correctly during crisis.

Indeed, increasing spending is a challenge in many country environments, as the most obvious risk is to simply waste public funds allocating them for issues which are not a priority. In order to avoid this, the best solution regarding major public works is to allocate funds for the "first-under-the-line" public programs (in a budget based on priorities, these are the programs which have been appraised and would be the top priority projects sustainable with a budget increment). Other measures could be targeted directly at consumers, to fight the three major causes of the plummet in consumer demand: loss of wealth, credit constraints, "under-the-mattress" savings in times of uncertainty. The solutions proposed are tax cuts and transfers to mitigate the hardships generated by credit constraints; and a clear commitment for government support against uncertainties.

The IMF however warns that whatever fiscal policy instrument is used, it must be sustainable in the medium term. Crucially, such measures should be implemented without generating serious macroeconomic and fiscal imbalances, such as excessive debt or recurrent spending that cripples the fiscal sector in the long run. An increase in public sector wages, for example, would not be advisable because for the same amount spent from the public budget it has less impact than other public spending, and the wages could not be reduced in the future. Debt or tax amnesties for companies in trouble prove to be distortionary, ineffective, and unfair on the market. In essence, the recommendation is that measures be reversible, countercyclical, based on solid medium-term frameworks (and covering public works that are conducive to long-run growth), and at the same time ensuring fiscal accountability and governance.

But where does Romania stand in this picture? Given the current conditions, could the Government use the fiscal policy and the budgets as an effective countercyclical instrument? The following section demonstrates that consistent reforms are needed to ensure that public finances are kept in check.

Background

In December 2008, the European Council endorsed the European Economic Recovery Plan, in which the European Commission called for a fiscal stimulus against the looming economic downturn. The stimulus would be differentiated across EU members according to the public finance sustainability and competitiveness of each member state, and would be reversed when the economic prospects improve. But just like many of the other new EU members, Romania has little space for a fiscal stimulus, and the best one could hope is that the widening fiscal gap could be embedded in a wider medium-term fiscal consolidation (2). The whole region (Eastern Europe and former Soviet countries) has seen in 2008-2009 the largest growth reversal in the past two decades (and Romania in particular experienced a 7.1% GDP growth in 2008 and expects a 4.1% contraction in 2009).

Romania's additional problem is that the fiscal policy of the recent growth years was completely unpredictable, widening the macro imbalances, while still pending structural reforms were left aside. The public sector continues to contribute over a third in the GDP, because privatizations came to a halt lately, and Romania lags behind the other new EU member states in terms of the transition to a market economy, in some respects even behind Bulgaria (3). The country missed the opportunity to finalize the fiscal consolidation and reform the budget process when the economy was booming; the Government conducted policies leading to a deficit as high as 5.4% in GDP while the economy grew 7.1% in real terms in 2008. The government spending doubled from 2005 to 2008, while the public sector share of economic activity grew from 31 to 37% of GDP (4).

One of the main messages of the present paper is the following: it is overly optimistic to expect that fiscal policy in 2009 or 2010 could act as an effective instrument against the crisis. On the contrary, the strong pro-cyclical fiscal stance has overheated the economy and exacerbated imbalances. At best one could hope the fiscal policy in 2009-2010 will not act as a deterrent while the economy is slowly recovering. In the worst case scenario, however, the need to cover absurd, inefficient public spending will crowd out the productive sector, eating up the little available liquidity on the market, and this could happen despite the strong conditionality of EU, IMF and the World Bank. Fiscal policies have been poorly managed in the past two years, as will be explained, and it is no wonder that Romania is the only country from the EU10 (new member states with a socialist past) which now practically has no fiscal stimulus package but only austerity measures (5). Because of the little room for maneuver, Romania is one of the three countries in the region which applied for a substantial multi-donor crisis package (Hungary and Latvia being the other two, while support for Poland is under discussion with the IMF). All of these are direct consequences of the conditions that prompted the European Commission to launch the excessive deficit procedure against Romania in April: the Commission explicitly states that the fiscal policies pursued by the Romanian Government were procyclical and outright chaotic during the period 2005-2008, fiscal gaps have widened to 5.4% of GDP in 2008 despite the fact that GDP growth averaged 6.5% per year and demand was booming (6).

Unfortunately, the quality of the budget process is far from what could be called best practice. As the public sector share is still so high in the economy, the impact of poor management of public funds is amplified. Deficiencies can be spotted everywhere: in the low capacity to prepare a coherent program, both in the Ministry of Finance and the line ministries; in the overestimation of revenues and expenditures by up to 10%. Decision makers are tempted to allocate important shares of the budget for ad-hoc social measures, for public sector wages, for pensions, without a proper assessment of the financial impact on the other programs or in the long run. In addition, since public budgets are in fact public statements on political priorities, the manner in which the fiscal policy was prepared these years offers a fairly accurate overall picture of public governance in Romania.

Looking at what has gone wrong in the fiscal policy is useful, while the crisis unfolds, for two reasons. First, we would know what to expect, realistically, from what the Government can actually do in the following months. Second--maybe even more importantly--the crisis is in itself an opportunity to reform under pressure, but on fast track, our public finances, just like the sheer bankruptcy in the second half of the '90s has triggered the transition to the market economy. But unfortunately, there is also a downside risk: the economic crisis can be an excellent excuse for bad governance, for frequent exceptions from the rule, and for opaque, corruption-generating policies. We are totally in tune with the World Bank's point of view that the reform in the public financial management to ensure spending effectiveness and efficiency is more urgent than before the crisis; and that the much-needed reforms should be the consistent introduction of the medium-term expenditure framework and the performance-based budgeting.

Mainly, the recommendation of this paper is that the following chronic deficiencies in the Romanian fiscal policy be analyzed and corrected.

1. Romania should have a budget for four years; instead, it has between four to six budgets a year.

It is very unlikely that the fiscal policy could be an effective tool against the crisis, when one cannot control the public finances well enough to prepare a predictable annual budget. Romania has, in general, an initially approved budget, three-four rectifications, and the final execution. Of course, budget amendments are allowed to ensure a certain flexibility, but the magnitude of the variations (see 2006), the frequency of changes and the fact that some of these rectifications are made as early as March (2008) says a great deal about the Government's capacity to prepare and implement a coherent strategy, even in years with economic growth that should have allowed for a strong fiscal consolidation. While it has never been a good performer in this matter, figures show that the situation has even worsened recently: Romania became in the past two-three years the EU member with the weakest budget programming in UE, with projections and forecasts further than ever from outturns, which makes them worthless as real policy targets. What is worse, this happens while formally Romania committed itself to the EU to improve its capacity to prepare programs, in order to catch up with the EU in terms of economic development and infrastructure, also attracting EU grants. From 2003 onwards as a pilot--and 2006 fully--Romania uses the "medium term expenditure framework" (MTEF): budgets are prepared for one year, with projections for the following three. Its underlying logic is simple: a coherent public policy requires a strategy to be followed and properly account for deviations. In addition, Romania prepares a convergence program (to the Euro zone) based on the same principles.

In reality, the Romanian "medium term expenditure framework" is a mere formality, even after the five years since it has been formally introduced. Though budgets are prepared indeed based on the programs proposed by the line ministries, there is no formal reconciliation between the current year's budget and forecasts prepared in the previous years. Thus, one can make any adjustment, without explanations or justifications required, which makes multi-year planning irrelevant. Moreover, for large infrastructure programs the plans and budgets are made indeed for several years; but after the program is drafted, the budget ceilings limit the spending for the current year. To still "squeeze" the strategy in the budget constraints, the remaining expenditures for the program are rolled over to the next years, keeping the total budget per program constant. This raises the forecasts to completely unrealistic levels for the following 2-3 years and renders the MTEF useless: no decision maker actually takes into account the future budget figures as a valid piece of information.

This simple fact is actually the key for a reform to improve the quality of programs and public spending in Romania. If deviations from forecasts to budgets and then actual spending would have to be motivated, a budget holder could not receive allocations without clear sectorial strategies approved and valid for several years. Strategies should allow for some flexibility, but not the volatility we see nowadays: Romania really should have just one transport strategy for several years instead of five highway strategies in one year. Amendments would still be possible, but they should be motivated, their budget impact properly calculated, and those responsible for the changes should be accountable. In addition, it is not clear how large budget rectifications would fit in the medium term expenditure framework, or how conflicts between rectified budgets and the Convergence program are avoided. This was one of the key considerations of the European Commission when it launched the Excessive Deficit Procedure for Romania.

To observers (be they the EU, World Bank or IMF), Romania is rather a country where strategic public policy is done in fits. The timid convergence that occurred towards the economic and monetary Eurozone, was due rather to a "natural" economic development in several good years of growth, just like a favorable drift accidentally pushes a boat on the right course, while the crew sleeps or rows in the opposite direction. During a crisis, though, this scenario is no longer acceptable.

Programming weaknesses lay both in the Ministry of Finance and line ministries. The Ministry of Finance has consistently and repeatedly overestimated budget revenues in recent years, as well as the capacity existing in line ministries to use the allocations for capital expenditures. This shows, most likely, not only the low technical capacity in the system. Rather, it was a political imperative: to create a fictitious "fiscal space", with the purpose to increase artificially the flexibility and opportunities for discretionary measures for those who handle the funds allocation. On the expenditure side, the system's weaknesses are thus very visible: the departments within the Ministry of Finance dealing with program budgets for sectors do not have access to data on how effective and efficient these programs are during implementation (for example, the return on investments or cost/benefit analyses, such data being collected at most only in a different department of the Ministry).

Line ministries in their turn typically prepare budgets in one department, strategies in another department, and the two rarely communicate with each other. In the budget preparation stage, budgets are passed back and forth from line ministries to the Ministry of Finance not for minute refinements, but subject to extremely large cuts; for example OECD estimated in 2005 that, if the Ministry of Finance would approve the full initial budget demands from line ministries, the deficit would exceed 22% of GDP a year (7). This means that line ministries perceive the budget ceilings received from the Ministry of Finance rather as negotiation starting points than as targets. In addition, recipients of budget allocations are experts at this negotiation game and have all reasons to overstate needs (we analyzed the road and rail maintenance strategies in one of our previous reports (8)). To make things worse, in many such cases sector strategies proposed for budget financing are wish lists with no prioritization.

The problem is aggravated by the fact that there is no strong government entity, under the direct authority of the Prime Minister, capable to ensure consistency among programs and strategies prepared by different ministries and check their actual simultaneous implementation, in order to establish proper links with the overarching government program. None of the parties which were in government paid too much attention to this particular institution: its role was played either by the Prime Minister's Chancellery (when a single party was governing) or by a Deputy Prime Minister, with a rather formal role (in coalition governments).

To sum up, despite the government's formal commitment to the medium term expenditure framework, in the EU-27 there are only 6 countries that rely less on this system than Romania; and according to an IMF report (9), Romania is on place 7 out of the 10 new EU members in terms of quality of budgetary procedures (surpassing Hungary, Slovakia and Bulgaria).

2. Several expenditure components are consistently overestimated (capital), whereas others (current costs) turn out to be much higher than planned.

Another indicator of poor planning and programming, deriving from the previous, is the fact that capital investment expenditures are overestimated every year (Fig 1). That is, funds initially allocated for investments cannot be absorbed in time, because of various reasons related to the system's capacity to implement complex projects. This is visible in the delays of major public works, which causes recurrent discussion such as the one about the four kilometers of highway built in the previous mandate (an admittedly over-simplified and incompletely informed public debate, but one which expresses a legitimate dissatisfaction). The fact that this phenomenon occurs regularly (Fig. 1), is a warning for the new Government who set itself an overly ambitious target to spend 20% of the budget on investments, both in the first budget and the rectification in April. Compared with the figures in Fig. 1, the initial budget amount meant 6.8% of GDP, that is, a third more than the 5% of GDP planned for 2008, a level which was not attained anyway. Without major institutional reforms and firm political will in this area, the target will most likely be missed; in reality, for the first 4 months of 2009 the capital expenditure dropped by 23% compared to the similar period of 2008.

[FIGURE 1 OMITTED]

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The substance of budget rectifications supports the findings, as shown above. Whenever budget amendments took place, either motivated by faster GDP growth or just reallocations among expenditure items, current costs and social measures registered the main increases. Among these were pensions, children allowances, transfers to local budgets for teachers' pay, heating allowances, public sector wages such as for police or administrative staff in ministries, wages of magistrates, plus current costs such as additional mining subsidies not planned in the initial drafting of the budget. Indeed, it is much easier to spend on social and other current costs than to prepare complex programs which require good capacity to absorb investments.

3. Expenditure spikes in November-December

Closely related to higher spending for social items, lack of capacity to prepare investments, and poor planning, expenditures in the last two months are much higher than in the rest of the year (Fig. 2). This shows that ministries and other budget recipients fear they would lose the unspent allocations and their budgets would be cut next year accordingly. Something of this kind could not happen if a real medium term expenditure framework were in place, as tenders for programs or procurement for current items would be spread evenly during the year. It is useless to discuss about the quality of the public investment in such a system, in which money is spent just to be spent.

In addition, analyzing the rectifications in the past two years, increases of expenditure were either a result of higher-than-expected GDP growth (generally the first rectifications in one year), or reallocations from other items (towards the end of the fiscal year). In the latter case, reallocations meant a reduction from investment accompanied by an increase in current costs. That is, whatever remained unspent from overly ambitious programs was rapidly reallocated to measures on which money could be spent as quickly as possible: subsidies, wage increases, procurement of goods and services which can be made simply and fast (soft expenditures).

4. Overestimation of budget revenues, whether fuelled by pre-election inflated promises or by inexperience, has become common practice in the past years.

Budget revenues increased indeed in real terms, a fact partially supported by the introduction of the flat tax and the reduction of social security contributions which reduced the informal economy. However, the growth forecasted by the Ministry of Finance for 2007 and 2008 as ratio to GDP was simply nonsensical (Fig. 3). One cannot expect the revenues to increase by 7.5% of GDP from one year to the next, when a similar miscalculation had occurred in the previous year. As the final execution in 2008 showed, the Government had expected revenues of 39.3% of GDP (36% on another methodology). They collected less than 33% (31%), about 86% of initially planned, less so because of collection problems but because of unrealistic initial plans.

[FIGURE 3 OMITTED]

In addition, increasing the share of consolidated budget revenues in GDP is not by itself a goal, as the former minister of Finance seemed to believe when he announced in high spirits in August 2007 that Romania would have in 2008 the first European budget with almost 40% of GDP budget revenues. First, one would have to make sure public money is used effectively, and the goal should be raising just enough revenues to meet one's programs. In the end, everything that the public sector collects is a resource taken away from the private sector, and there is no golden rule "the more the government crowds out the private sector, the better".

Budget revenues targets are easy to miss also because Romania's taxes are highly volatile. Social contributions are decreasing gradually; just recently, the trend was reversed, when they were increased by 3.8 pps. A few months ago, one of the parties (PSD), now in power, announced its intention to abandon the flat tax or increase its level, which has not happened so far. We also have the highest number worldwide of different taxes for companies (113 a year compared to just 2 in other EU countries, according to a World Bank study (10)). One should not forget the never-ending story of the first registration tax for cars, which has lasted for more than one year and is still not over. In short, transaction costs for individuals and companies (red paper and hassle) are high enough to perpetuate the informal economy, mainly because of the high uncertainties, even if the general tax burden is not excessive.

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Under these circumstances, estimates for budget revenues should have been extremely prudent, in particular because, while revenues can fall short of initial expectations, expenditures tend to be as high as in the initial budgets. If revenues are lower than expected, the deficit is widening fast, which is exactly what we are witnessing now. If revenues should be higher, we should have a modest surplus; this happens in general when there is economic growth, and when debts should be repaid and reserves increased to face deficits in the following years. In these terms, Romania fares rather badly compared to other countries. The gap between the headline and the cyclically-adjusted deficit (the deficit if we exclude the positive effect of increasing revenues when the economy is growing fast) is much higher in the case of Romania compared to other EU members.

On top of everything, even the resources available from the EU grants are underutilized. In 2007, immediately after accession, the Romanian budget managed to absorb only 0.75% of GDP instead of the initially planned 2%. In 2008, the actually absorbed funds were 1.6% of GDP lower than planned (that is, just above a quarter of the available funds). Considering there is sincere commitment for full utilization of EU funds, the underutilization can be explained by the inability to improve the administrative procedures and prepare good programs for fund absorption, and respond coherently and timely to the demands from the private sector.

5. Arbitrary budget allocations: a step back from good governance and a reversal of previous reforms.

Two controversial allocations took place in 2008, one in the initial budget, another in the third rectification. The Ministry of Finance transferred 700 mn EUR, and 600 mn EUR, respectively, to the County Councils, which had full discretion in their further distribution for local projects. Just in 2007, reforms in decentralization had succeeded, after more than a decade of efforts, in establishing an objective, transparent formula for all transfers from the Ministry of Finance to local administrations. The reforms were meant to improve local autonomy from the higher levels of government, particularly from the County Councils whose presidents, in some cases, allegedly gained rents from their discretionary powers in budget allocations to local governments (hence their nickname "local barons" in the media).

The two allocations in 2008 were made expressly as an "exception to the rule" (the law of local public finance) and consisted of sums topping those allocated according to the law-established formula. This money was again distributed at the will of the county councils leadership, a return to the primitive budgetary practices from the first half of the '90s. Several crucial changes in the administration took place at the same time. First, from 2008, County Council presidents are directly elected by the people and claim more legitimacy.

Then, after the November elections, the media reported alleged negotiations between the two ruling parties (PD-L and PSD) to change the Prefects with party affiliates. The Prefects should be representatives of the central government at County Council levels, who mainly check the legality of decisions made by subnational governments, including county councils, and are supposed to be civil servants, not political appointees. Together, these evolutions are crucial for the quality of local governance in the future. In the most sinister scenario, the Romanian administration is deliberately moving towards absolute, unchecked powers of county council presidents. In the best case, the budget transfers in 2008 were irresponsible allocations before elections with a potential to become dangerous precedents. Such "exceptions" from established rules, if tolerated by the public opinion, are likely to become common practice in 2009 having the crisis as an excuse; however, the losses in terms of governance could be enormous. In this context, the recent decentralization reform, giving more responsibilities and funds to counties, should be pursued with utmost care, in order not to reinforce this worrying trend.

Until now, the new Government has done nothing but to cancel the effects of the last budget allocation in 2009, mainly by claiming back the amounts that had not been spent at local level (the big bulk of them), in order to reduce the consolidated deficit. We highly recommend that the Government should commit formally to make transfers to local authorities only by the law--not by exception--and by automated mechanisms, transparently and predictably.

6. Large shares of public budgets are allocated to sectors with high recurrent costs (education, health, agriculture, rail transport)

There is definitely room to streamline the expenditure in several sectors, where recurrent costs are high and could be better rationalized. Examples include: the introduction of symbolic co-payment schemes for certain free medical services in order to reduce excess demand (like in Hungary in the late '90s); some revisions of drugs compensation schemes, hospital rationalization; introduction of student loans; reduction of subsidies to the railways system by spinning off 2,500 km of lines which were supposed to be dismantled six years ago and are still subsidized etc. Only the latter measure could save up to 1 bn. EUR per year. All these measures have been proposed in the past in various public policy reports and never applied. The economic crisis and the need to reduce the deficit can be an excellent opportunity to finally implement such measures.

Fixing a certain ceiling for different sectors (e.g., 6% for education etc.) is actually a source of inefficiencies and a deterrent to cost rationalization, if allocations are not linked to some sort of performance standards. The share in GDP of the budget allocated to education, for example, is double compared to five years ago; however, there was no notable improvement in the quality of the education system, measured in average student performance relative to other countries. Similarly, if the teachers' pay is increased, these raises should be linked to some measure of performance and not general. The limitation of pay increases in 2009 because of unavailable funding could be made politically acceptable by introducing a form of performance-based raise, an action that is urgent if we consider the recent strong opposition of trade unions against the postponement of pay raises.

7. The public sector wage bill increases and pensions promised in the past two years, combined with a GDP contraction (estimated 4% this year) are a serious threat to the deficit in 2009

The most important component of the budget deficit in 2009 (40%) is generated by the gradual implementation of pension raises (the increase of the "pension point" by 45% in just two years). Total pensions, raises included, currently represent no less than 8% of GDP, if all promises would be met. No Romanian politician had the courage to explain fully and systematically to the public opinion these cold figures and the realities behind them, worsened by the recent rash decisions in the Parliament or Government.

At the same time, the public sector wage bill grew from 4.5% of GDP in 2004 to over 6.5% in 2008 and would have increased even more if the pre-electoral promises to raise salaries for teachers were actually implemented. Currently, the Government attempts a sharp reduction in the public sector wages, a sector with strong trade unions that includes more than a third of the official labor force in Romania and benefited significant salary raises in the recent years, higher than those in the private sector and above the total real GDP growth of about 40% (Fig. 5).

[FIGURE 5 OMITTED]

In the pre-election campaign a lot of promises were made, which are currently not likely to be fulfilled under the current budget restraints. Targeted benefits (minimum income guarantees, allowances for mothers, children allowances), which were about 0.5% of GDP in 2008 would have reached 1.2% of expected GDP in 2009 if all promises were to be kept. The successive wage raises (there were no less than 3 in 2008 for teachers) led to a substantial increase in personnel costs even without further adjustments: in the first 4 months of 2009 staff costs exceeded the amount in the similar period of 2008 by 2.3 bn. RON (500 mn. EUR).

Since the effects of the crisis are already felt, with increases in unemployment, one could expect extra expenditures such as higher spending on unemployment benefits. However, the total social assistance mentioned by the new minister would not exceed 2% of GDP. The budget maintains a target of 6% of GDP for education.

8. Deficits are very expensive now for Romania In 2008, the last two rectifications added a worrying 1.3 bn. RON (about 350 mn. EUR) to the interest payments related to public debt. Romania's public debt grew from 17% of GDP in 2007, 20% in 2008 and an estimated 24% in 2009, faring still well compared to other EU countries, but deteriorating slowly. In addition, the borrowing terms for the Ministry of Finance became more restrictive on the international markets after Romania's rating was downgraded by Fitch and Standard & Poor's to below investment grade. As a consequence, to cover the deficit, the government borrowed increasingly from the domestic market, at higher and higher interest rates; in October and November, the Ministry of Finance borrowed 3.7 bn RON in terms close to those of the Lombard credit facility of the National Bank (14.25% interest). Only in December the Ministry of Finance raised 2.8 bn. RON in treasury certificates (3M, 6M, 12M) and 600 mn. in bonds (3 and 5 years).

What is even worse, the fact that the Ministry of Finance seeks more and more funding on the domestic market crowds out private investment, with a negative consequence on the economic recovery. Only in the past 6 months (December-May) the Government borrowed over 32 bn. RON domestically from private banks and became their largest customer, and it wants to borrow 7.5 bn. more in June. At the same time, the interest payments in the first 4 months of 2009 grew by 87% compared to the similar period of 2008.

Increasing restrictions on available financing will probably be more effective in containing the budget deficits in 2009, rather than the government's willingness or capacity to remain within the 3% limit set by the Maastricht Treaty. A big push towards more responsibility could be the fact that the European Commission launched the Excessive Deficit Procedure against Romania in April. One should not neglect that if the limits set by the Maastricht Treaty are exceeded (3% of GDP deficit, 60% public debt) and the Government fails to take corrective measures, the Cohesion Funds could be suspended partially or in full. It is possible that the government will be tempted to tap cheaper and more readily available resources, such as the reserve funds or maybe even the proceeds from previous privatizations, which are now in the National Development Fund (NDF). This would be the worst solution, because privatization proceeds are one-off funds and, in addition, at least in the foreseeable future, no new privatizations will take place. Luckily, Romania obtained a 20 bn. EUR multilateral loan from IMF, EC, World Bank, EIB, EBRD, with conditionality for good governance: the 13 bn. from IMF reduce for the moment the burden on the public sector to support the banking system against a crisis, and the loan from the World Bank is a direct budget support.

WHAT HAS BEEN DONE

To sum up the measures of the new Government (some of which were already mentioned), these are focused on reducing fiscal imbalances, improve the credibility of fiscal policies, and the medium-term sustainability of such policies. Some measures are targeted at the protection of the poor and vulnerable from the impact of the crisis, others seek to minimize the risk of a systemic financial crisis by improving regulation. Many of these measures (as we are accustomed to in Romania, unfortunately) resulted from strong external pressures: the launch of the excessive deficit procedure by the European Commission, and the joint EU-IMF-World Bank conditionality for the 20 bn. EUR support.

The measures are short term, such as those included in the April rectification of the budget reduce the estimated deficit to a more realistic 5.2% of GDP in 2009 (in the absence of these measures the deficit would have been 8-9% of GDP, according to IMF staff estimates). These consist of the social contribution increase (3.8 pps); removal of a VAT reduced rate, cuts in public sector wage bill by eliminating 137,000 vacant (but budgeted) positions and reductions in goods and services. An additional 0.6% of GDP deficit reduction would result from the trigger actions of the IMF loan.

Other measures are longer term in effect, and will cut recurrent costs. The Government has recently drafted a long-overdue strategy to rationalize spending for the public sector wages: most notably, the unitary pay law, which is under preparation. All these measures are highly unpopular and are strongly opposed, in particular by trade unions of teachers and special sector staff (magistrates, judges) which are losing key bonuses and benefits. Another measure is the full introduction of the MTEF and the approval of a Fiscal Responsibility Law, to limit discretionary or unpredictable spending. In this respect, the IMF conditions its 13 bn. EUR loan by a requirement that the Government approve a Fiscal Responsibility Law, which would include: "i) a framework for improved multiyear budgeting; ii) limits on intra-year budget revisions; iii) fiscal rules on expenditures, public debt and the primary deficit; iv) the creation of an independent fiscal council; and v) a framework for managing guarantees and other contingent liabilities". (11) The reforms lead to increased responsibility for deviations from the agreed framework, by defining the broad categories of personnel and capital expenditures and approving in Parliament also the composition of spending on broad items (not only the aggregate amount).

WHAT SHOULD BE DONE

* The budget process must become more transparent and the Ministry of Finance and line ministries should improve their administrative capacity

For all the reasons explained above, it is very unlikely that the fiscal policy stance could be changed to anti-cyclical in 2009-2010, after the major slippages during periods of economic growth. But we can hope that fiscal imbalances can be corrected and the deficit controlled. This can be implemented most effectively not by increasing revenues (despite some attempts, such as the fixed tax on companies and social security contributions increase), but by rationalizing expenditures within a wider medium term reform. Actually, we saw that a clear commitment to reforms could generate additional revenues to the public sector: IMF, EU and the World Bank are conditioning their support by a clear program for reform, to make sure that funds are not wasted or misused. Indeed, capacity building is rather a long process, but it must accelerate now, if previous opportunities were lost. The crisis could actually open the window of opportunity for reform towards better fiscal policy.

If budgets are indeed to be prepared based on the medium term expenditure framework, they must be clearly linked with macroeconomic developments, and deviations from initial programs should be clearly justified. The introduction of new projects or measures must be analyzed in a cost-benefit perspective and compared with alternative use of public monies (opportunity cost). In addition, it is crucial that solid institutions are in place to check the use of public funds. This depends on the performance of both internal auditors in spending agencies and the external auditor (Court of Accounts). One must understand though the constraints: while the IMF required Fiscal Responsibility Law (which contains all of the above) can be enacted by administrative fiat, the proper implementation is not easy. It requires a diligent effort, assistance to staff in charge with the programs, and careful monitoring to make sure reforms are not done solely on paper. This is a deep, structural reform that will take several years for implementation, but the upside to the crisis is that it finally triggered the need for such reforms with long-term effects. These measures are not likely to be implemented when government revenues are abundant, allowing waste in the public spending, and without external pressure.

But in addition to what the donors require, the budgetary performance and execution must also become more transparent to the public, especially in crisis times. The same applies to the activity of the external auditor of public institutions (Court of Accounts). Regarding the availability of public information, the Ministry of Finance does not publish currently detailed, updated information on the budgetary execution, comparison of execution with initial plans, or updates of plans resulting from budget rectifications. Also, the activity of the Court of Accounts is quite obscure to the general public.

* At least until better predictions can be made, forecasts should be very prudent, particularly on the revenues side, and unnecessary expenditure must be cut

There is no need for specialist knowledge to realize that a "jump" in fiscal revenues by 6-7% of GDP is completely unrealistic. What is more, even in countries with better established fiscal institutions forecasting what will happen with budget revenues in 2009 is quite difficult, so prudence is critical. If revenues are overestimated again, and expenditures match the overstated revenues, this would widen the deficits to be covered by non-renewable resources such as privatization proceeds or reserve funds.

Regarding expenditures, again, we view this crisis as an opportunity: to adjust the administration structure and pay in the public sector. It will be much more difficult than it seems to cut the public sector wages (inevitable however in 2009 because of the deficit). These measures will be strongly opposed by the employees unless they can be defended on solid grounds, like a credible reform in the administration. The strikes in the Hungarian public sector are a preview of what would happen if the public sector employees are living with a feeling of injustice. General, common criteria for payments, bonuses, promotions, or firing in the entire bureaucratic system are needed, so that differences would not be regarded as targeted against one particular category.

* Budget volatility must be reduced, if fiscal policy is not to deepen the economic crisis

While some flexibility is needed, amendments should not be triggered by sudden changes of policies or, even worse, "recollections" of items which had been missed during the initial drafting of the budget. Rectifications should be caused mainly by changes in macroeconomic forecasts, resulting from a periodic planned review of macro indicators by the Prognosis Commission and the Ministry of Finance. At the same time, exceptions to the rule this time motivated by "the general interest during crisis times"--must be avoided, such as additional transfers to local budgets, county councils, by-passes of the procurement law (like at the beginning of the year for energy). The long-term losses in terms of good governance would be much higher than the short-term gains, if any, and may reverse past reforms pursued with significant efforts in the past

In conclusion, the solutions in the short run are the same as the long-term recommendations in budget policy--and in that we agree with all the donors. Unless fiscal institutions are consolidated, the government cannot "command" over its fiscal policy, in order to use it as an instrument against recession or at least to contain additional pressures on an ailing economy. Unless the planning and programming capacity is increased in the Ministry of Finance and line ministries, significant shares of public money are still allocated for inefficient purposes, in a time when the private productive sector, without which economic recovery is impossible, finds financing with difficulties. Savings in areas where funds are spent inefficiently, coupled with prudent estimates for revenues would ensure fiscal policy does not continue its pro-cyclical effects during crisis.

REFERENCES

* European Bank for Reconstruction and Development, 2008. Transition Report

* European Commission, 2009. Report on the Excessive Deficit Procedure for Romania, available on-line at: http://ec.europa.eu/economy _finance/publications/publication_summary15137_ en.htm

* Eurostat, 2008. http://epp.eurostat.ec.europa .eu/portal/page/portal/eurostat/home/

* International Monetary Fund, 2008. Country Report 8/210, Romania: Selected Issues, available on-line at: http://www.imf. org/external /pubs/ft/scr/2008/cr08210.pdf

* National Institute for Statistics, 2008. www.insse.ro

* Nutu, A.O., 2008. Roads to Nowhere, Romanian Journal of Political Science 2/2008

* Spillimbergo, A., Symansky, S., Blanchard, O., Cottarelli, C., 2008. Fiscal Policy for the Crisis. Staff Position Note, International Monetary Fund.

* Ruffner, M., Wehner, J., Witt, M., 2005. Budgeting in Romania, OECD

* World Bank, 2009. Bottoming out? EU 10 Regular Economic Report

* World Bank, 2008. Doing Business Report

* World Bank, 2009. DPL Project Document, unpublished report

(1) The following section is adapted from Spillimbergo, A., Symansky, S., Blanchard, O., Cottarelli, C., "Fiscal Policy for the Crisis", International Monetary Fund, Staff Position Note, December 2008. The report suggests several fiscal policy instruments that could be implemented successfully around the world to fight the crisis, adapted to local conditions.

(2) World Bank, EU 10 Regular Economic Report, "Bottoming out?", May 2009

(3) Bulgaria stands better in terms of: privatization (small and large scale), competition policy, banking reform. European Bank for Reconstruction and Development, Transition Report 2008

(4) World Bank estimates, unpublished report.

(5) A summary of fiscal measures in the region is available in World Bank, EU 10 Regular Economic Report, "Bottoming out?", May 2009, p. 24-25. The austerity measures for Romania consist of a very brave attempt to freeze wages and reduce bonuses on the expenditure side, and increase revenues by introducing minimum taxes for companies, cutting VAT exemptions and increasing social security contributions by 3.8%. The recently proposed program "First Home", consisting of state guarantees for mortgage loans, is supposed to have off-budget effects.

(6) European Commission, Report on the Excessive Deficit Procedure for Romania, http://ec.europa.eu/economy_finance/publications/publication_summary15137_ en.htm. "Deficits were also driven by a weak budgetary planning and execution and a lack of predictability and discipline, which resulted in systematic budgetary slippages. In 2008, the deficit outturn was more than twice the official target and this significant deviation is mostly due to weak budgetary management with frequent ad-hoc budgetary amendments, using overly optimistic revenue projections to increase expenditure and shifting capital to current spending".

(7) Ruffner, M., Wehner, J., Witt, M., Budgeting in Romania, OECD, 2005

(8) Roads to Nowhere. SAR Policy brief no. 26, august 2007. www.sar.org.ro

(9) International Monetary Fund Country Report 8/210, Romania: Selected Issues, July 2008, http://www.imf.org/external/pubs/ft/scr/2008/cr08210.pdf

(10) World Bank, Doing Business 2008

(11) World Bank, DPL Project Document, May 2009, p. 17

* Otilia Nutu is a consultant working for the World Bank and the Romanian Academic Society. Sorin Ionita is the research director of the Romanian Academic Society.
Tab. 1. Budget volatility in Romania

                  Maximum         Minimum
      Initial  deficit after   deficit after   Final
      deficit  rectifications  rectifications  outturn

2006  -0.50%       -2.50%          -0.90%      -1.70%
2007  -2.70%       -2.80%          -2.40%      -2.50%
2008  -2.75%       -2.30%          -2.30%      -4.8% (-5.4% on ESA95)

Tab. 2. Deficit components in 2008 (% of GDP)

Initially planned
deficit                   -2.8
                           5.5
Revenue
overestimation

--EU funds          1.6
--non-fiscal        1.4
  revenues          1.3
--VAT               1.2
--lower revenues
  because of the
  crisis

Expenditure                3.5
overestimation

Total deficit             -4.8

Source. Ministry of Finance and own estimations
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Author:Nutu, Ana Otilia; Ionita, Sorin
Publication:Romanian Journal of Political Science
Article Type:Report
Geographic Code:4EXRO
Date:Mar 22, 2009
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