Economic reform in 1997

Romania's transition from a totalitarian system and an excessively centralised economy to a democratic state of law and a market economy involves a twofold purpose:

• the national goal - free and competitive development of society;
• the global goal, linked with the integration of the current European and international structures, based on the principles of a highly performing partnership.

An evaluation of the process of transition undertaken thusfar leads us to the conclusion that:

• relatively long-term scheduling of the sectoral re-structuring strategies;
• the need for a total change of the legal and institutional system;
• the scarcity of indigenous financial resources;
• the narrow access to foreign corporate financing; brought about a slower response by commercial companies when adapting to the changes in their work conditions. This has had direct consequences on the extension of macroeconomic instability and the overcharge of the bill for social reform.

The governments which succeeded to executive power after 1990 used to draw up economic macrostability programmes for one, or at most two years. This was without ever defining the direction of development on a medium and long-term basis, which is imperiously necessary for when commercial companies make their forecasts.

While most countries are concerned with identifying new policies, enabling them to make the transition towards the 21st century and after, Romania needs a longer economic prospect. This should take into consideration the national interest for Romania's accession to the European Union (EU), world globalisation trends, and the growth of economic interdependencies. These will involve talks and approaches which go beyond the country's borders.

For the 1997 economic programme, as well as for the future projection of Romanian economic development, Romania's membership to the EU means it should attain a certain level of development, eliminating the gap between our country and other industrialised European countries in the field of technology.

Macroeconomic policy

The 1997 programme of the new Government has had two specific goals:

• to implement prudent fiscal and monetary policy in order to secure macroeconomic stabilisation;
• to launch far-reaching structural reforms to underpin the stabilisation effort and place the Romanian economy on the path to renewed growth.

The macroeconomic policies for 1997 have significantly reduced deficits in the general government and the state enterprise sectors through major fiscal adjustments, including an effective income policy and measures to enhance financial discipline.

Over the first ten months of 1997 the general government fiscal deficit was kept on track. By the end of 1997 it was below the targeted 4,5 per cent of Gross Domestic Product (GDP), and well below the 1996 level of 5,7 per cent of GDP. On the strength of these policies, a significant deceleration in inflation during 1997 was programmed. Inflation is expected to be about 150 per cent from January to December 1997 - this high figure being the unavoidable result of the price adjustment, especially in the first quarter of the year.

In order to accomplish a significant reform in terms of public expenditure, it was necessary to introduce a transparent policy of budgetary funds allocation, according to social needs and the reduction of state implication in the real economy. At the same time as making expenditure savings, it was important to give special consideration to social protection, in light of the drastic reform and re-structuring programmes implemented over the year.

Funds amounting to about ten per cent of GDP (up by about two per cent of GDP from 1996) have been allocated to protect the most vulnerable groups, such as children, retired people and those employees laid off as a consequence of the re-structuring process. Also, expenditures for health and education have been largely shielded from expenditure cuts. However, more than half the support to enterprises in industry and agriculture sectors, including quasi-fiscal subsidies previously provided by the National Bank of Romania (NBR), have been cut from 7,6 per cent of GDP in 1996 to 2,4 per cent of GDP in 1997 (as of September 1997) on an accrual basis. Wages have been curtailed in the public sector (indexed at 75 per cent of inflation), and the number of personnel has been reduced by around ten per cent. Given the budgetary constraints, it has been necessary to reduce public investments in infrastructure and other areas during 1997.

On the revenue side, due to the enterprise re-structuring process, a number of measures have been taken to sustain inflow under the circumstances of the tax base contraction. Most of the exemptions from custom duties have been removed. VAT and profit tax exemptions have been eliminated. Decisions to increase excises on alcohol and tobacco products, and taxes on domestic oil and natural gas production, were also adopted. There has been full use of existing legal and institutional arrangements for enforcing tax compliance, including the collection of tax arrears.

Concerning the monetary policy, in 1997, for the first time in the past seven years, the NBR was allowed to conduct its monetary policy without governmental control. This was an integral part of the macrostabilisation programme. By halting the practices of burdening the monetary policy of quasi-fiscal functions, NBR could implement its strategy of foreign exchange market liberalisation.

Structural reforms

Besides restrictive monetary and fiscal policies, the range of the 1997 economic policy initiatives included robust structural reforms. The aim was to secure the sustainability of macroeconomic stabilisation, to foster private sector development, and to resume economic growth on a sound basis. The main components of the structural reforms are:

Liberalising prices and markets. Prices for goods and services which people consumed were liberalised or adjusted to realistic levels. (Prices for services such as utilities must remain supervised). In February, the Government started to liberalise the price of energy, public services and agricultural products. In February, gasoline and diesel prices, which had already doubled in January, rose again by some 50 per cent; the price of rail tickets rose by 80 per cent; telecommunications by 100 per cent and electricity by up to 500 per cent. After reaching a peak (monthly rate) of 30,7 per cent in March, monthly inflation decreased to a low of 0,7 per cent in July. Taking into account the changes in administered prices and seasonal variations, the further increases, due mainly to the wage index, does not suggest additional inflationary pressure.

Concerning trade, the Government is aware that Romanian industries require competition in order to re-structure and become more competitive. Therefore, most privileges, restrictions and quotas for imports were abolished in March, 1997. Today Romania, for whom most OECD countries have guaranteed the most favoured nation status, has an average customs tariff rate of approximately 14 per cent. Conforming with the provisions of the Association Agreement with the EU, the Government intends to decrease the average weighted rate of the customs tariffs for industrial imports from the EU to five per cent by the year 2000. The Government also intends to promote exports by eliminating regulations and quotas that inhibit them, attracting foreign investors, and liberalising access to import.

Privatisation of the state sector. In 1997 the privatisation process was characterised by an improvement of sale methods, based on the market price. Ten months after the beginning of the year, the State Ownership Fund privatised 1300 companies, 34 of which are large companies. The sectors recording the highest rates of privatisation, in 1997 are the agriculture and food industry (670 companies), tourism and trade (210 companies), wood and furniture industry (50 companies). In most sectors, more than 70 per cent of the value-added is produced by the private sector, except for industry, where it accounts for 25 per cent. Altogether, the private sector accounted for 52 per cent of 1996 GDP.

Re-structuring of large state-owned companies and regies autonomes. With the approach of a new Government, re-structuring means rapid privatisation of viable companies and liquidation of the non-viable economic agents through the court of administrative procedures. They have closed some 13 large state-owned enterprises which were making a loss and are now advancing on a further 12 in a similar category. Specifically, they have closed the refineries, a sector which is grossly over capacity in Romania. The privatisation of ROMTELECOM is advancing quickly, with ROMOIL and ROMGAZ in close pursuit. During the first month of 1998 all the RAs will be converted to commercial companies and will be slated for privatisation. Given the large size of these companies, the success of this new phase of re-structuring will very much depend on the participation of strategic investors; foreign direct investment could play a crucial role in this process.

The strengthening of the financial sector. The Government have continued to support the growing activity in the RASDAQ and Bucharest Stock Exchange. In mid-October 1997 RASDAQ quoted around 3200 companies and BSE almost 70. According to the VAB (Vanguard) Index, the volume of capitalisation of RASDAQ was over US$2,5 billion, and of the BSE over $700 million in August 1997. Starting with October 1997, the official BSE index is BET.

Parliament has passed a new law for bank privatisation, allowing full participation of overseas parties in the banking system. It has recognised the value of an open market, which allows the best international experience to develop financial services in a country like Romania. They have announced the rapid privatisation of two large state-owned banks, the Romanian Development Bank and BancPost, and have also appointed advisers. Furthermore, they have taken the necessary steps to deal with problem banks.

Reform of the agricultural sector. In agriculture, one of the biggest challenges was the elimination of directed credits to agriculture. Instead, the budget was used to provide funds to this sector.

There has been visible progress in terms of the privatisation process of the remaining state-owned companies in the agricultural sector. Over 25 large loss making farms were liquidated and/or privatised, and many more are in the process of privatisation. A more open import and export regime for agricultural products, clear in principle, predictable in application, uniform and rule-based, has been adopted. There have also been important adjustments to the legal framework for the land market, in order to develop a competitive environment for land transactions (including sales and leasing).

Recent economic developments

The deep structural reforms enacted across the main sectors:

• the liquidation of large loss-makers and non-viable companies which could not find buyers;
• the completion of the re-structure of the mining sector;
• the return of utilities to financial equilibrium through the adoption of adequate tariffs for their services;
• the liberalisation of trade practices and prices with the aim of removing former distortions, instead creating a market-based field for all enterprises led in 1997.

When compared with the same period of the previous year, statistics have revealed a 4,4 per cent decrease of the industrial output index. Energy resources had decreased by 6,1 per cent and the trade sector turnover by 30,2 per cent. Industrial output was reduced by ten per cent in the case of consumer goods production and 5,6 per cent for intermediate goods, while economic activity in construction was reduced by 27,6 per cent. Capital goods remained at the 1996 level.

The number of employees decreased by 5,2 per cent in September 1997 compared to December 1996, while in industry the fall totalled 7,5 per cent. For the two major fields the diminutions were, 33,9 per cent for mining and quarrying and 7,1 per cent in manufacturing. The unemployment rate registered 7,6 per cent.

The period January to November 1997 has been characterised by an average monthly inflation rate of 8,7 per cent. This led to the loss of business confidence and a subsequent contraction of one-third of investments.

All these domestic circumstances converged to a drop of GDP, estimated at 6,5 per cent against 1996.

The inflation and stagnation of domestic economic activity has caused household purchasing power to deteriorate gradually. In short, private consumption is expected to reach -4,5 per cent.

With investments dropping below 20 per cent of GDP and consumption components decreasing (private consumption by 4,5 per cent and public consumption by seven per cent), domestic aggregate demand fell by 8,2 per cent. Conditions in the external sector are expected to improve due to the 5,1 per cent increase in exports.

Despite this period of deterioration, the Romanian economy is expected to become relatively healthy, due to the structural adjustment policies currently in operation. Growth will be resumed in 1998 (+2,5 per cent), but will remain below the Romanian economic potential. This is due to the continuing re-structuring process, rather than the position of Government finances. However, medium-term improvement is expected, based on the completion of privatisation and fiscal reforms.

The medium-term economic outlook

To provide sustainable economic growth after the macrostabilisation period of the Romanian economy (1997-1998), the major target of the economic policy will shift from the process of supporting economic activity to ensuring sustainable economic recovery. This will involve taking adequate measures to reduce possible tensions and pressures that might arise during a full expansion process, thereby boosting its viability on a medium-term basis.

The main risk factors for future economic activity include:

• another outburst of both inflation and the component parts of financial lack of discipline, along with the magnitude of the economic revival;
• the possibility of budgetary non-sustainable deficits;
• the inability to adjust the commodity and labour markets to the transformation process currently underway.

It is expected that the GDP will attain annual average growth rates exceeding 3.5 per cent (comparable prices) during 1998-2000. The trend of a faster growth of industrial production, as against the domestic demand which is expected for the second part of the projection period, will lead to reduced pressure on price increases. So, the risk of a growing inflation rate will diminish. The average annual inflation rate will decrease to 15 and 17 per cent towards the end of the century.

Investment and exports will be the most dynamic components of the demand, while the administrative expenditures are to be kept at restrictive levels during the entire period of projection. The average annual growth rates of private consumption are expected to be +3,5 per cent in 1999 and +4,0 per cent in the year 2000. This shows that as the economy recovers, distribution of the proceeds of economic growth to individual households becomes more favourable. Improvement of their disposable income will allow an increase of about 65.5 per cent in the private consumption share of the GDP in the year 2000.

Economic growth will be supported by the development of the private sector - an essential strategic option performed through shifts of ownership from the public to the private sector. It is estimated that the private sector share in GDP will be approximately 80,0 per cent. The following has been taken into account:

• the privatisation of state-owned commercial companies;
• an additional gross value-added achieved by those state-owned companies which are being privatised. Increased efficiency of their economic performances will enable them to come closer to those of private commercial companies;
• disconnection from the existing regies autonomous of auxiliary services and other associated activities, while including them in new commercial companies;
• the total or partial re-organisation of the regies autonomous in commercial companies, by selling the shares issued by them;
• the expansion of small and medium-sized companies (SMC). This is the most dynamic sector of the market, due to both their ability to adapt to changes within the economic environment, and their long-term development potential. This enables them to ensure the absorption of the labour force, made available during the process of re-structuring and liquidation of non-viable companies.

It is appreciated that the participation of SMC to the GDP will reach 69.5 per cent in the year 2000. Approximately 86 per cent will be from the contribution made by the private ownership sector.

The investment process will continue to be a an invigorating item of social and economic development, and a pillar for sustainable economic growth. Taking into consideration the present economic resources available and the restrained possibilities for formation of financial resources, a moderate increase in investment, higher than GDP rates, is expected. The private sector will continue to grow, as will the diminishing public sector, in accordance with the re-definition of the state role and that of commercial companies.

The main factors able to support investment development are:

• an increased propensity to invest in private companies;
• economic revival of industry, agriculture, transport and services;
• privatisation and re-structuring of state-owned companies and regies autonomous;
• encouraging foreign investment in important economic sectors.

Guidance of public investment mainly towards the strategic sectors (coal extraction, nuclear programme, education and training, health, social protection, urban planning and technical works, environment preservation, national defence and public order) aims at narrowing the gap between developed and less developed countries. It also prepares Romania for integration into the EEC and its accession to the structures of the Northern-Atlantic Alliance.

The increased competitiveness of the Romanian economy on the international market, is part of Romania's endeavour to enhance its position in the contemporary world. The main tool of its macroeconomic management is its economic export oriented policy, which will be performed through active promotion of manufactured Romanian goods on external markets.

Within the framework of the global economy, towards the end of the century Romanian exports are expected to reach a rate similar to that of world trade (5,5 per cent, yearly).

The importation of raw materials and fuel, expected during the following years, is necessary for economic growth and export increases. Furthermore, the growth of imports of capital goods is aimed at modernisation and upgrading of the economy. It is likely that these imports will exceed $2,2 billion by the year 2000, along with a slight decline of the importation of consumer goods, which are to be supplied from the domestic market. The current account deficit will be steadily reduced, and national deposits of foreign currencies will be enhanced. Meanwhile, the external debt will remain at those annual levels accepted by international financing.