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2018 european-semester-country-report-romania-en

1. EN EN EUROPEAN COMMISSION Brussels, 7.3.2018 SWD(2018) 221 final COMMISSION STAFF WORKING DOCUMENT Country Report Romania 2018 Accompanying the document COMMUNICATION…
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  • 1. EN EN EUROPEAN COMMISSION Brussels, 7.3.2018 SWD(2018) 221 final COMMISSION STAFF WORKING DOCUMENT Country Report Romania 2018 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2018 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2018) 120 final}
  • 2. Executive summary 1 1. Economic situation and outlook 4 2. Progress with country-specific recommendations 11 3. Reform priorities 15 3.1. Public finances and taxation 15 3.2. Financial sector 20 3.3. Labour market, education and social policies 23 3.4. Investment 32 3.5. Sectoral policies 42 Annex A: Overview table 46 Annex B: Macroeconomic Imbalance Procedure scoreboard 53 Annex C: Standard tables 54 References 60 LIST OF TABLES Table 1.1: Key economic, financial and social indicators – Romania 10 Table 2.1: Summary table on CSR assessment 13 Table B.1: The Macroeconomic Imbalances Procedure scoreboard for Romania (AMR 2018) 53 Table C.1: Financial market indicators 54 Table C.2: Headline Social Scoreboard indicators 55 Table C.3: Labour market and education indicators 56 Table C.4: Social inclusion and health indicators 57 Table C.5: Product market performance and policy indicators 58 Table C.6: Green growth 59 LIST OF GRAPHS Graph 1.1: GDP components and output gap 4 Graph 1.2: Contributions to potential growth 4 Graph 1.3: GDP by region 5 CONTENTS
  • 3. Graph 1.4: Gross fixed capital formation 5 Graph 1.5: Current account breakdown 6 Graph 1.6: Harmonised index of consumer prices (HICP) inflation in constant taxes 6 Graph 1.7: Labour market outcomes 7 Graph 1.8: Population, natural change and net migration 7 Graph 1.9: Breakdown of change in general government balance 9 Graph 1.10: Loans to households and non-financial corporations 9 Graph 1.11: Share of debt in companies facing financial stress 9 Graph 2.1: Overall multiannual implementation of 2011-2017 CSRs to date 11 Graph 3.1.1: Redistributive power of the tax and benefit system in EU Member States, 2016 15 Graph 3.1.2: Romania: VAT Revenues, VAT theoretical tax liability (VTTL) and VAT gap 16 Graph 3.1.3: Public debt projection 2017-2028 19 Graph 3.2.1: Pension funds' real net investment rate of return, Dec 2016 (preliminary) 22 Graph 3.3.1: Nominal compensation per employee and GDP per person employed 23 Graph 3.3.2: People at risk of poverty or social exclusion by degree of urbanisation 27 Graph 3.3.3: Early school leaving rates 29 Graph 3.3.4: Proportion of people with health insurance, registered with a family practitioner 30 Graph 3.4.1: Net international investment position 32 Graph 3.4.2: FDI flows by investment type 32 Graph 3.4.3: Nominal unit labour cost, growth breakdown 33 Graph 3.4.4: Share of export value by quality category, in manufacturing 33 Graph 3.4.5: Export market share by industry 33 Graph 3.4.6: Export market share by country 34 Graph 3.4.7: Changes in regional and global value chain trade 34 Graph 3.4.8: GDP per capita and quality of infrastructure 35 Graph 3.4.9: Ease of doing business 36 Graph 3.4.10: Award of contracts for single bids in 2017 40 Graph 3.5.1: Regional Innovation performance in Romania 42 Graph 3.5.2: Business R&D intensity, 2007 and 2016 42 Graph 3.5.3: Logistics Performance Index 2016 44 LIST OF BOXES Box 2.1: Tangible results delivered through EU support to structural change in Romania 14 Box 3.1.1: Emergency Ordinance No 79/2017: distributive and macroeconomic impact 17 Box 3.3.1: Monitoring performance in light of the European Pillar of Social Rights 24 Box 3.3.2: Main challenges for the education system as a driver of growth in Romania 31 Box 3.4.1: Investment challenges and reforms in Romania 41 Box 3.5.1: Policy highlights: ICT innovative cluster development and advanced manufacturing in West Romania 45
  • 4. 1 In the absence of structural reforms and fiscal consolidation, Romaniaʼs buoyant economic growth risks setting the stage for a hard landing. The current economic boom has been driven mainly by consumption, while investment has remained subdued. The strong economic upswing represents an opportunity to rebuild fiscal buffers and prepare the economy for leaner times. Inequality and poverty rates remain high despite the strong economic growth. Some structural reforms were reversed in 2017 while others stalled. The progress made in the fight against corruption was again put at risk. Ensuring continuity of past reforms would support Romania's transformation to a higher value added economy and could improve the economyʼs resilience to an eventual downturn (1 ). The economyʼs cyclical upswing continued in 2017 but is expected to ease off in 2018. Real GDP growth accelerated in 2017 to a post-crisis high on the back of booming private consumption, spurred by wage hikes in both the public and private sector and indirect tax cuts. Growth is forecast to decelerate but stay above potential. Despite export market share gains, the growth of imports has outpaced that of exports and the current account deficit is widening. Inflation turned positive in 2017 and is forecast to accelerate. The labour market has been tightening in line with the strong economic growth. Employment growth was positive in 2017 (0.7 %) and the unemployment rate dropped to 4.9 %, its lowest level in more than 20 years. The low unemployment rate, coupled with a declining labour force and persistent skills shortages, has led to very tight labour market conditions. The compensation of employees is low relative to the EU average but the strong wage growth of 2017, also driven by a 16 % minimum wage hike and public sector wage increases, risks putting pressure on competitiveness and inflation, if not (1 ) This report assesses Romania’s economy in the light of the European Commission’s Annual Growth Survey published on 22 November 2017. In the survey, the Commission calls on EU Member States to implement reforms to make the European economy more productive, resilient and inclusive. In so doing, Member States should focus their efforts on the three elements of the virtuous triangle of economic policy — boosting investment, pursuing structural reforms and ensuring responsible fiscal policies. accompanied by corresponding productivity increases. Due to tax cuts and increases in public wages and pensions, the public deficit is on an increasing path. Indirect taxes were cut in 2017 while the personal income tax rate was cut from January 2018. On the expenditure side, public wages and old-age pensions were significantly increased in 2017 and are set to advance further in 2018. As a consequence, the nominal and structural budget deficits are on an increasing path, causing Romania to diverge from the targets in its national fiscal framework. In 2017 the Council launched a significant deviation procedure addressed to Romania. The financial sector has further strengthened, whereas some segments need monitoring. The banking sector remains well-capitalised and its overall health, including asset quality, has continued to improve. However, recurrent legislative initiatives warrant close monitoring. The insurance sector is strengthening, as the measures to address the financial situation of weaker companies have started to bear fruit. The recent reduction in the contributions to the pre- funded second pillar pension funds, which have displayed strong performance since they were set up, eased short term fiscal concerns but could have negative implications for the development of capital markets. Romania has made limited progress on addressing the 2017 country-specific recommendations. No progress was made on ensuring that the national fiscal framework is implemented and there was limited progress in strengthening tax compliance and collection. By contrast, there was some progress on fighting undeclared work while limited progress was made on strengthening targeted labour activation measures. No progress was made on how the minimum wage is set and on equalising the pensionable age for men and women. Limited progress was made on improving access to quality mainstream education. In the healthcare system, limited progress was made on shifting to outpatient care and some progress was achieved on curbing informal payments. There was limited progress on adopting legislation to ensure a professional and independent civil service and on prioritising public investment. Finally, some progress was made on EXECUTIVE SUMMARY
  • 5. Executive summary 2 implementing the national public procurement strategy, but sustainability of measures and irreversibility of reforms should be further monitored. Regarding progress in reaching the national targets under the Europe 2020 strategy, Romania is performing well in the areas of employment rates, national greenhouse gas emission, renewable energy, energy efficiency and tertiary education. The national target for reducing the number of people at risk of poverty or social exclusion has already been reached. However, research and development intensity and early school leaving remain some distance away from their respective targets. Romania faces challenges with regard to a number of indicators of the Social Scoreboard supporting the European Pillar of Social Rights. The high economic growth has translated into improved employment outcomes and resulted in a strong increase of household disposable incomes. However, Romania has a high number of early school leavers, and young people not in education, employment or training. Romania has not yet achieved a mature social dialogue, and on social protection and inclusion, challenges remain. Key structural issues analysed in this report, which point to particular challenges for Romania's economy, are the following:  Labour and skills supply are not keeping up with the fast-changing needs of the economy. Romaniaʼs unfavourable demographic trends are expected to continue. Population aging, limited internal labour mobility and continued emigration represent a significant drag on potential economic growth. Despite recent improvements, labour force participation rates remain well below EU averages. This concerns particularly women, older people, Roma, young people, and people in rural areas. Active labour market policies are insufficient in scope and design. Skills shortages and mismatches have an adverse impact on competitiveness and convergence. Undeclared work continues to distort the labour market. Minimum wage increases are decided in a discretionary manner while social partnersʼ involvement in policy- making is very limited, with no substantive process of involvement and cooperation. Collective bargaining rates are low.  Poverty increased and income inequality remains high. Inequality of opportunity remains a challenge, especially for rural areas. Income inequality is high, while the redistributive effect of the tax and benefit system is below the EU average. The limited integration of employment, education and social services prevents disadvantaged groups from escaping poverty. The provision of services is limited, especially in disadvantaged areas. Child poverty is high and rising. The entry into force of the Law on minimum inclusion income that would increase the adequacy and coverage of social benefits was postponed again to 2019. Legislation equalising pension ages for men and women has not been adopted. The adopted shift of social security contributions places the burden of financing social protection almost entirely on employees. Access to social protection for all is not ensured.  No tangible results were achieved on public administration reforms, and the business environment shows weaknesses. Draft legislation on human resource management is currently aligned with the strategy for civil servants but implementation has not started and results are expected only in 2019. The public consultation process, strategic and budgetary planning as well as the use of regulatory impact assessments remains weak, limiting evidence- based policy making. Cumbersome administrative procedures for businesses, slow progress in the provision of e-government solutions, complex insolvency procedures and frequent regulatory changes with limited use of impact assessment and consultation procedures weigh on the business environment.  The weak performance of the education system limits growth prospects in the long run. Low attainment levels in basic skills and digital skills, persistently high early school leaving, poor Roma inclusion and rural-urban disparities in education result in lost human capital and growth potential. Quality assurance and initial teacher education programmes face challenges. Vocational education and training
  • 6. Executive summary 3 remains a second choice option and in most cases is not adapted to labour market needs. Access to adult learning is limited, in particular for the low-skilled.  The health status of the population has improved, but remains below EU standards. Access to healthcare remains a key challenge, also in relation to equality of opportunities, with negative repercussions on child development, workforce employability and healthy ageing. Low funding and inefficient use of public resources limit the health systemʼs effectiveness, against the background of a sizeable shortage of doctors and nurses. Health infrastructure and the prevalence of informal payments remain sources of concern.  Performance in the area of research and innovation remains modest. Despite a solid IT infrastructure and the rapid development of the ICT sector, Romania continues to score low on all European Innovation Scoreboard indicators and there are no signs of improving performance. The degree of digitisation of both the public and private sector remain very low. Despite increasing public funding and a dynamic start-up ecosystem, technology adoption, internationalisation and scaling-up of companies remain significant challenges. The weak innovation performance could have a negative impact on growth prospects.  High public spending is not reflected in the countryʼs infrastructure. Despite relatively high public investment rates, the supply of infrastructure is limited, with the perceived quality of infrastructure being one of the lowest in the EU. The general condition and reliability of road and rail infrastructure remain poor and the reform of the transport sector progresses very slowly. Water, waste and energy infrastructure remain deficient. State-owned enterprises’ efficiency is not improving and the corporate governance framework is being weakened. Public investment is characterised by low efficiency particularly in project preparation and prioritisation and public procurement. Businesses see investment in infrastructure as a major priority for public spending.  The irreversibility of the progress in the fight against corruption was recently put at risk. The continued good results of the judicial institutions in the fight against corruption were largely brought into question by events throughout the past year. The ongoing reforms of the justice laws risk harming judicial independence and undoing progress achieved over the past 10 years. Moreover, judicial institutions and the legal framework for fighting corruption crimes continue to be under intense pressure.
  • 7. 4 GDP and potential growth Growth accelerated further in 2017, fuelled by domestic demand. Real GDP is estimated to have increased by 6.7 % in 2017, following the 4.8 % advance in 2016, marking a new post-crisis peak. Real GDP growth is forecast to ease off but remain above potential growth, at 4.5 % in 2018 and 4.0 % in 2019. Private consumption was the main contributor to growth in 2017, supported by indirect tax cuts and wage hikes both in the public and the private sectors. Private consumption is forecast to slow down in 2018, as inflation increasingly weighs on real disposable income, but is expected to remain the main growth driver. The output gap, which is estimated to have turned positive in 2017, is projected to increase further as actual GDP growth continues to outpace potential growth. Graph 1.1: GDP components and output gap Source: European Commission This strong upswing will not be sustainable in the absence of reforms to increase the economy’s potential. Private consumption has accounted for most of the strong growth over the past few years, supported by a pro-cyclical fiscal policy (2 ) (Graph 1.1). In contrast, the contribution of investment to GDP growth has mostly been modest in recent years. In the longer run, insufficient progress on implementing structural reforms supporting investment and the (2 ) Loosening fiscal policy when the economy is doing well and tightening it when the economy is doing badly transformation to a higher value added economy will constrain economic growth (see Section 3). Potential growth has improved somewhat driven mainly by total factor productivity. Potential growth is estimated to have been around 3.7 % in 2017, compared to an average of 4.6 % over 2000-2008 (Graph 1.2). Growth in total factor productivity (3 ) has been the main driver of potential growth since 2012 and is expected to remain so in the coming years. The contribution of capital accumulation continued to be positive, but smaller compared to pre-crisis times. The contribution of labour was close to zero in 2016 and is estimated to have remained so in 2017 as the effects of a shrinking working-age population and a falling unemployment rate cancelled each other out. Demographics will continue to weigh on growth, calling for sustained improvements to labour productivity (both through total factor productivity growth and more efficient investment) and to labour force participation so as to allow further convergence towards EU average income levels (see Sections 3.3-3.5). Graph 1.2: Contributions to potential growth Source: European Commission Per capita GDP is converging towards EU averages but regional disparities persist. GDP per capita in Romania increased from slightly more than 40 % of the EU average at the time of accession in 2007 to almost 60 % in 2016. Nevertheless, Romania remains one of the EU countries with the lowest GDP per capita. (3 ) Change in output that cannot be accounted for by the change in either labour or capital inputs. -25 -20 -15 -10 -5 0 5 10 15 09 10 11 12 13 14 15 16 17 18 19 ppsofGDP HH cons. Gov. cons GFCF Net exports Inventories GDP forecast -2 -1 0 1 2 3 4 5 6 7 8 9 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 ppsofpotentialGDP forecast Capital Contribution TFP Contribution Labour Contribution Potential Growth 1. ECONOMIC SITUATION AND OUTLOOK
  • 8. 1. Economic situation and outlook 5 Although all regions have made progress on GDP convergence, the capital region advanced at a markedly faster pace with GDP per capita reaching almost 140 % of the EU average in 2015, further widening the already large gap with the rest of the country (Graph 1.3). Graph 1.3: GDP by region (1)GDP in purchasing power standard (PPS) per inhabitant as a percentage of the EU average Source: European Commission Investment Romania has one of the highest investment ratios in the EU but the quality of investment is not improving. Total investment reached 22.7 % of GDP in 2016, above the average for the EU (19.8 %) and for the new Member States (19.9 %) (Graph 1.4), consistent with the catching-up process of the Romanian economy. However, the quality of public investment remains constrained by management deficiencies, frequently changing priorities and difficulties in absorbing EU funds while private investment is hampered by continued legal uncertainty and red tape (see Section 3.4). After a contraction in 2016, investment growth started to recover in
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