Last week Romanian government published the 113 pages long 2012-2014 Fiscal Strategy (FS). As I do not trust the media to draw the most important conclusions from such a document I read it myself.
This was not leisure reading and was not fun. The language used is dry, the sentences are long and the economics is poor. But I have to do it as there should be clues, from actions taken, about future path of macro variables in Romania.
I will not bore you with all the details. Instead I will do a general to specific interpretation of this document.
1) The ideas, mostly basic economic theory, are good. However, the implementation is left to the future. For example the FS claims that in the next two years the government will start paying its bills faster (it understands the negative effects of not doing so now). Or that it will spend more money on investments, infrastructure, reform the health systems etc. All great ideas but they are put, yet again in the FS at future tense. While the need for action is today. I would have liked to see at least sentences that start with: “We have already done important steps in the direction of…”, ” We are in the final stages of pushing through this bill that helps….” etc.
2) The are many good actions proposed in the FS. The stability and predictability of the fiscal code. Or restructuring and controlling public sector expenditures. However, the questions remains: how do you make these binding? Is anything going to happen if they do not get implemented? So far it seems to me that, Romania (actually not only), has not been punished by the electorate or the markets yet. Maybe things need to get really bad before we see a real transformation.
To me, until I see real progress I will take these ideas with a lot of grain of salt.
3) The assumptions used for estimating future revenues and expenditures are not up to date. They are not updated for global economy or for Romania. This is something that has been covered by media also. Basically, there is a positive bias in the forecasts. With such numbers it is easy to assume higher revenues and then budget higher expenditures. I would not really have a problem with these as in current times forecasting is almost impossible. But, at least for Romania recent data from NBR shows that the economy is slowing down.
4) The growth engines on which the FS rests its case, gross fixed capital formation and private consumption, are still
them more cash in their pocket (i.e. currency appreciation, lower income taxes). You want firms to invest you have to give them tax breaks. As global demand is not picking up and as your FS strategy depends on local demand you need to help the local demand with incentives. At least temporary ones. Otherwise I do not see how consumer will increase consumption on average with 4% a year in the next two years. Or how GFCF will increase on average 7.5% a year in the next two years. Both of those showed negative rates of growth relative to Q4 2010. Even more important total final consumption, which includes government expenditures, shows contraction relative to Q4 2010. (all data available the August Inflation Report from NBR).
Let’s move onto the specifics.
5) Revenues look very odd to me. How come as the GDP is expected to grow by 4.3% on average for the next three years revenues do not increase as percentage above 34%? Revenues dropped as percentage as the economy decreased thus we should expect them to increase when the economy recovers. Where does this asymmetry come from ?
Also, the recent evolution of revenues is not encouraging for economic growth. Both income and profit revenues have decreased in 2010 relative to 2009. The increase in VAT revenues I see it as temporary as it did apply to existing contracts in the economy .Going forward the higher VAT will push some of the commercial transactions into underground, postpone some investments, reduce demand for durable goods.
The most important sources of revenue for Romania are VAT and Social Contributions (17% of GDP). While revenues from income only represent 3% of GDP. This is one more reason for which I think there is good opportunity to lower income tax (lose 1% of GDP from this revenues source) in order to allow people to consume more (or pay their debts). Some of the lost revenue will be back through VAT and some through profit tax.
Most importantly revenues could be grossly overstated by the assumptions for economic growth.
6) Expenditures are set to decrease to around 36% of GDP in 2014 from a current 38% of GDP. This is good news, if it actually happens. Looking inside there are few points that need to be raised:
a) wage expenditures will actually increase and by 2014 in nominal terms will be higher than in 2009
b) wage expenditures will still be a major drag on the budget in 2014. If we put wages and expenditures on goods and services together they will be 50% higher than investments.
c) social security expenditures will increase and will be 24% higher in 2014 than in 2009.
With these developments I wonder were is the drop in expenditures going to be located. Sure, they do not increase at the pace of GDP, but in nominal terms they do increase significantly.
As you can see there is a major problem if the assumptions for growth are overstated. In fact the whole story has the key in these assumptions. If they are wrong, then revenues will undershoot and expenditures will push the deficits higher. Taking into account the current economic developments I say this scenario is very likely in the absence of policies that will induce consumption and investments.
The fiscal strategy in figures here: FSgraphs