Romania: Govt pledges 5%-of-GDP gap in 2024, fiscal adjustment is softened by elections

• Deficit to drop below 3% of GDP in 2027, Romania to remain under EC's EDP
• Fiscal consolidation is modest due to costly reforms, relaxed income policy in election year
• New fiscal-measures are announced with 4%-of-GDP positive fiscal impact, we see it unrealistic
• Positive effects of fiscal consolidation may be offset by rise in tax evasion in absence of complete digitisation
• Revenue growth is backed by unrealistic GDP growth forecast, elimination of tax breaks
• Planned expenditure rise is milder, we doubt subsidies and transfers will drop in election year
• We think the budget plan once more underestimates expenditure and overestimates revenue

The government targets a 5%-of-GDP general government budget gap in 2024, narrowing from 5.9% estimated in 2023 (cash terms), according to the finance ministry's draft budget plan published today for public debate. Hence, Romania will remain under the EC's excessive deficit procedure, with the deficit estimated to drop below 3% of GDP only in 2027. The modest fiscal consolidation targeted in 2024 comes from a series of fiscal measures that eliminate or reduce the impact of tax breaks, some public-administration spending cap, and another quite unrealistic economic growth projection of 3.4%. This should revive budget revenue by RON 50bn (3% of GDP), as government representatives bragged.

The finance ministry projects a very slow fiscal consolidation, justified by a difficult external context, expensive structural reforms and large past-year deficits. On top of those, we could add a rather relaxed income policy in view in 2024, when four rounds of elections are scheduled, and persistent ambiguity regarding the cost of the energy support schemes that will be maintained until March 2025. Furthermore, the government promises once more to boost investment. Even though the financing is mainly backed by EU funds, the national co-financing should be secured from the state budget. It's true that investment spending has been traditionally cut every time fiscal slippages occurred, while absorbing EU money has never reached targets.

Weak attempts to fiscal-consolidate by gradual elimination of tax breaks ahead of elections

The general government budget has been quite stretched this year. The finance ministry candidly announced in April that the budget plan for 2023 was far from accurate. The budget revenue forecast in Q1 was missed by a lot, which triggered a RON 20bn increase in the budget deficit target in 2023 (RON 69bn or 4.4% of GDP, both cash and ESA). A first step was to issue a?bill reducing budget expenditure, with an estimated RON 5.3bn fiscal impact in the entire year. The amount was far from enough to fix the slippage, needless to say that many public authorities failed to apply it thoroughly. Wage hikes forced by social tensions and strikes of public sector employees, failure to absorb NRRP and EU money as planned in the budget and costly pension reform made the situation worse. New?sets of fiscal measures?were implemented, mostly eliminating tax breaks and capping administration spending, with the biggest impact in 2024.

Another fiscal-measures bill was published with the budget plan, as previous measures were not enough. It includes a 5% increase in public-sector employees, 20% increase in wages in education in two stages (13% as of January and the rest as of August), a bonus cap at the 2023 level. Extra work time in the public administration will not be paid but offset with additional paid leave. Measures also include a 13.8% increase in pensions and other social benefits, delay of some benefits, lower subsidies, fewer expense categories deductible for various contributors, measures to strengthen fiscal discipline and to increase administrative capacity of the finance ministry. This new bill's fiscal impact was estimated at RON 3.3bn in terms of revenue growth and RON 63.8bn expenditure decrease in 2024, though this latter was not explained in detail, and we see it as rather implausible.

Modest deficit narrowing in 2024 is backed by revenue rebound from economic growth, income hikes

The budget plan is built on 3.4% economic growth, recovering from the estimated 2.0% y/y in 2023. The government estimates a 1.2% increase in supply, backed by the industry's recovery, construction's growth sustained by EU funds, and a 3.5% advance of services sector. Agricultural output is estimated to prudently rise by 5.7%, being sensitive to climate conditions. On the demand side, the government sees 1.7pps positive contribution of investment and consumption recovery by 3.4% with 2.1pps contribution to growth.

Expenditure is projected to rise at a milder pace than revenue, which should ground a smaller deficit in 2024. Like in 2023, developments of main categories look rather unrealistic, especially when looking at subsidy and interest expense estimations on the expenditure side, and on VAT collection - on the revenue side.

• Revenue

The government has received numerous recommendations from IFIs to eliminate tax breaks and facilities in the tax system to revive budget revenue, which still has a low share of GDP compared to peers (around 34%). Some adjustments were adopted this year, but mush is to be done in this regard. The projected revenue growth (12.6% y/y) should come chiefly from double-digit rises in revenue from social contributions (probably counting on minimum wage hike and salary increases in the public sector. It will be coupled with an estimated higher number of employees and elimination of exempts in construction and agriculture) and VAT collections. Those generally look quite uncertain, in our view, considering the authorities' poor track record in improving VAT collection and still feeble consumption recovery. It's true that the elimination of several tax breaks should have positive effects on VAT collection, yet that might also fuel tax evasion, with the opposite impact. Therefore, the revenue forecast might very probably be overestimated.

• Expenditure

The expenditure structure remains rigid, despite repeated promises to improve this aspect and commitments of structural reform in administration. Expenditure is planned to rise slower than revenue. Like in 2023, expenditure's planned increase is mainly on the back of a boost in investment. Yet, historically, past cabinets had usually cut investment when the deficit needed to narrow and other expenditure components were underestimated. This is happening in 2023, and it happened in 2022. Hence, we have sold reasons to believe it would most probably be the same in 2024. The projected social expenditure is seen to rise by 10.4%, while personnel costs - by 11.4% y/y. Yet, both expenditure categories are subject to major uncertainties, considering the unclear impact of the new pension law and potential wage hike demands in the public sector in the context of the unadjusted unitary wage bill in the public sector. Moreover, other transfers and subsidies are planned to decrease, despite heavy borrowing at higher costs in the past years and still uncertain costs of support schemes in energy. Obviously, the government assures it will cover most of it with EU money, which is conditioned by reforms.

Broadly, authorities are mostly counting on economic growth acceleration, despite fiscal tightening, more revenue from VAT and social contributions following tax breaks elimination, even if that might increase tax evasion. Not significant savings are planned when looking at administrative expense, while the optimistic forecast of lower subsidies and transfers are highly unlikely in an election year, in our view. EU transfers are seen at about the same level as this year, but that might also be an overestimation, considering the realisation of EU funds absorption from both RRF and MFF in 2023. Therefore, we once more think that the finance ministry underestimated expenditure and overestimated revenue in the 2024 budget plan.