Macroeconomic Challenges for New EU Member States: Romania a Case in Point

1. Macroeconomic Challenges for New EU Member States: Romania a Case in Point by Tonny Lybek IMF’s Resident Representative in Romania and Bulgaria tlybek@imf.org at European Policies Initiative Open Society Institute & World Bank Sofia October 19, 2009

2. Agenda • I: World Economic Outlook • II: Regional Outlook: • From excessive credit growth to a credit crunch • III: The role of the IMF • IV: Romania as a case in point • V: Conclusion

3. I.1 Global Outlook • Deepest global recession since the 1930’s! • In 2009, world growth expected to decline by 1.1 percent for the first time in 60 years. • Selected indicators: • International trade • Commodity prices • Capital flows slowing down • Type of shock: how long will it last? • Financial shocks typically last longer • No obvious locomotive • Signs of recovery? Risks have moderated!

4. I.2 World Economic Outlook

5. II.1 Regional Outlook • The Good Times 2003–07—Catching-up: • Central and Eastern Europe (CEE) real GDP growth averaged 6%: • Strong global GDP growth boosted exports of CEE. • Capital inflows boosted domestic demand: • Liberalized, integrated, preparing for EU accession. • Western Banks expanded aggressively in Emerging Europe. • Fiscal deficits reduced and public debt ratios declined: • Except in Hungary (public debt) and Romania (fiscal deficit) • Public finances looked much better than they were! • Vulnerabilities building-up: • Current account deficits widened to unsustainable levels! • Exposures to Western European banks increased! • Credit growth was very rapid => asset price booms; • Much of the lending was in foreign currency • Private sector external debt increased to very high levels!

6. II.2 Current Account Deficits Increased

7. II.3 Increasing Exposure to Western Banks

8. II.4 Much of The Lending in FX

9. II.5 Impact of The Global Crisis • Lower external demand • Slowdown in capital inflows: • Foreign direct investment (FDI) • Funding of—mainly foreign-owned—banks • Direct borrowing by non-financial companies • Slow-down in domestic demand: • Uncertainty about employment • Slower wage growth and lower remittances • Wealth effects (asset prices) • Some already ripe for a home-grown crisis: • IMF has tried to stress differences in the region!

10. II.6 Regional Economic Outlook

11. III.1 The Role of The IMF • Mitigating the impact of the global crisis: • Reform of IMF facilities: • Streamlining conditionality: • Focus on macroeconomic stability • Reduce detailed structural conditionality • Adjust set of facilities: • Introduce Flexible Credit Line (FCL) • Enhance Stand-By Arrangement (SBA) • Increase access to funding • Further encourage policy coordination: • Macroeconomic policies • Financial sector regulation

12. III.2 IMF Lending Activities

13. IV.1 Romania: A Case in Point • Global crisis made it increasingly difficult to secure external financing: • Large short-term private debt • Large fiscal imbalances even in good years, make financing challenging during a recession => Emerging credibility problem! => In need of a “safety belt”!!

14. IV.2 Romania’s Package • Joint package supporting Romania’s program! • Size of the “safety belt” (€20 billion over 2 years): • IMF: May 4; 24-month Stand-By Arrangement with exceptional access €12.95 billion (1110.77% of quota). Interest rate about 3½% and repayment over 3–5 years. • EU*: May 5; ECOFIN Council approved the framework for a €5 billion loan, a maximum of five installments over 24 months (on top of pre-and post-accession funds and the advance payment of structural funds in 2009). Interest rate is libor + spread and an “average maturity of maximum 7 years”. • World Bank*: 2009–10, 3 DPLs of total €1 billion. Interest rate will depend on the maturity, currency, and if fixed or floating rate. • EBRD and other multilateral IFIs (EIB): various projects, about €1 billion. *Also budget support

15. IV.2 Romania’s Economic Program • Foreign banks committed to maintain exposure • Government addresses fiscal imbalances: • Fiscal consolidation: ensure sustainability! • Improve fiscal governance: ensure predictability! • NBR continues to maintain sound banking system: • Ensure prompt and early action • Price stability remains primary objective of monetary policy => Reduce uncertainty and “noise”! => Facilitate more efficient financial intermediation!

16. IV.3 Ensure Fiscal Sustainability • Budget deficits: March adjustment 1.1% of GDP August adjustment 0.8 % of GDP March August • 2009 -4.6% -7.3% • 2010 -3⅔% -5.9% • 2011 better than-3% -4.3% • Public salaries • Vulnerable groups • Arrears of general government • Government guarantees • Balance following factors: • Back on a sustainable path • Realistic financing • Avoid excessive cuts exacerbating the recession

17. IV.4 Ensure Fiscal Predictability • Tax administration • Restructuring of public sector • *Public compensation reform (“unitary public pay law): • Simplified pay scale, reduce reliance on bonuses • More transparent • Equity • Save resources • Better monitoring of public enterprises • *Fiscal responsibility act: • Multi-year budgets • Independent fiscal council • Local governments and self-financed units • *Pension reform: • Broaden coverage • Index to inflation instead of wages • Increase gradually the retirement age * New legislation

18. IV.5 Market Reactions

19. V Conclusion • Global financial crisis is deep! • The IMF is mitigating the crisis by: • Providing financing to smooth the adjustment: • Should not be an excuse to delay structural reforms! • Functioning as an external anchor provided authorities are committed! • Further encourage global policy coordination: • Macroeconomic policies • Financial sector regulation • Adjustments are necessary: • Credible, sustainable, and predictable fiscal policies • Prudential regulation allowing adequate buffers

20. Thank you very much for your attention