Romania: Finance ministry plans slow fiscal adjustment, amid weak growth in medium term

• Budget gap should narrow by 1% of GDP annually, down to 2.5% of GDP in 2031
• Economic growth to slow to 2% in 2031, consumption to rebecome main growth driver
• NRRP fiscal reform, improved tax collection, higher royalties to revive current revenue to 31.1% of GDP in 2031
• Unconvincing ideas to make savings, reduce wage growths in administration

The finance ministry has published the 7-year fiscal consolidation plan that should bring down the budget deficit below 3% of GDP by 2031. The authority will start from a 7.9%-of-GDP gap (ESA) that was estimated for this year, higher than 6.9% of GDP EC forecast and announced at the budget revision about a month ago. Therefore, the annual adjustment of the structural deficit in the following 7 years will be bigger (1% of GDP) than initially discussed with the Commission (0.74% of GDP), according to this plan. Fiscal consolidation will result into a 2.5%-of-GDP budget deficit in 2031, when public debt will reach 61.4% of GDP. Debt will enter a gradual falling path over the following 10 years. Local authorities proposed this slow fiscal consolidation arguing that large deficits for longer period are necessary for a consolidated economic recovery driven mainly by investment. Yet, despite promises to keep public investment at high levels in the period, projected economic growth will be weak in the medium term.

Economic growth will moderate in the following years, dropping below potential growth in 2025, due to fiscal consolidation measures. The gap between domestic output and demand will remain high, narrowing only towards the end of the period, due to persistently robust wage growth in the context of economic activity contraction and in absence of external demand recovery. Investment growth will remain above economic growth, but will slow down, being outpaced by consumption by the end of the period. The CA gap will also narrow, but at slower pace than the fiscal deficit due to intensification of capital goods import, necessary for implementing major investment projects.

Improved tax collection is again among factors sustaining budget revenue rise

The finance ministry plans to increase current revenue to 31.1% of GDP in 2031 from 29.6% of GDP in 2024. This rise is grounded on the projected GDP growth, the fiscal reform committed in the NRRP with 1.1%-of-GDP fiscal impact, improved tax collection with 0.7%-of-GDP fiscal impact, royalties' adjustment and the start of the Black Sea gas exploration in 2026.

The tax reform commitment in the NRRP will be implemented with WB assistance, consisting in fiscal reform scenarios submitted to the government in Q1 2025. Hence, specific fiscal measures are not yet available, although they should be aligned to NRRP objectives referring to increasing tax base for several taxes, canceling tax exemptions and tax breaks, eliminating tax optimization situations, adjusting property taxes and royalties. Measures aiming to improve tax collection are vague and the finance ministry has not explained how it calculated their fiscal impact. For example, the authority plans to set up a mechanism for early detection of VAT fraud, to implement anti-fraud modules for assessing suspicious transactions, to increase fraud detection through digitization, to better monitor fiscal documents, to develop a system for contributor profiling, but does not provide more explanations for making those intentions credible. The adjustment of the controversial tax regime of micro firms is also in view, but with a smaller fiscal impact, 0.1% of GDP.

Changing public procurement practices to make savings may be challenging

On the expenditure side, its share to GDP should fall to 35.9% in 2031 from 41.9% in 2024. The finance ministry commits to make administrative spending savings and to gradually reduce personnel spending share to GDP through a slower wage growth in the public sector. Social expenses should loser their share to the GDP, which the government says is the medium-term impact of the new pension law. Public investment will retain a major share of GDP, namely 7.9% of GDP in 2025, 7.7% of GDP in 2026, 6.6% of GDP in 2027, followed by a constant 5% of GDP in the following years.

Administrative savings are grounded on meeting several objectives like linking purchases to average prices for goods and services, centralized acquisitions, setting KPIs and saving targets. Although practical, we are skeptical that those ideas will pay results applied to the public administration staff that is used to other practices. The reform of the unitary wage law in the public sector that has been generating numerous wage hikes in the past years, is postponed until the fiscal deficit narrows to 5% of GDP. Yet, the finance ministry committed to implement a clear and transparent mechanism for minimum wage hikes. Both measures make us question how the share to GDP of public personnel spending with gradually reduce, since many public-servant wages and bonuses are linked to the minimum wage and numerous categories still have overdue wage hikes provided in the current unitary wage bill.

Overall, the finance ministry commits to a gradual fiscal adjustment for avoiding economic downturn and for keeping public investment at a considerable level in order to increase potential GDP. However, the investment is projected to be largely covered by EU non-reimbursable funding from the RRF and MFF allocations to Romania, and absorption of those funds has been quite challenging for the government so far. The finance ministry once more promises to reduce tax evasion, reduce tax optimization and to make savings, which is unconvincing considering past actions in these areas. Most measures are abstract while actions on specific taxes are not mentioned, keeping the fiscal system unpredictable.