OFFICIAL            La 339          L
DOCUMENTS
LETTER OF DEVELOPMENT POLICY
MINISTRY OF PUBLIC FINANCE
Mr. Jim Yong Kim
President
World Bank
Washington, DC. US
Dear Mr. Kim,
The Government of Romania has embarked on a comprehensive reform agenda to accelerate Romania's
convergence towards EU incomes and living standards. This agenda aims to strengthen domestic and
international investor's confidence in our economy via a continued strong macroeconomic management and
a number of structural reforms to boost productivity and economic growth. We are confident that the
successful implementation of this agenda will lead to further improvements in the living conditions of all
Romania's citizens.
We welcome the support that the World Bank, jointly with the European Commission and the International
Monetary Fund, have provided to our Government's reform agenda, in particular through the ongoing
Development Policy Loan with a Deferred Drawdown Option that was approved in mid-2012.  In this
context, we request the Bank's continued support for the next stage of our reform program with a new
Development Policy Loan (DPL) Programmatic Series. This letter outlines the main directions of
macroeconomic policy and structural reforms underpinning the first DPL series.
Macroeconomic and Financial Framework
Romania weathered the global crisis well, thanks to the sound economic management and moderate public
debt, and continued reforms with strong support of our international development partners. Economic growth
last year accelerated to 3.5 percent. But given the uncertain international economic environment, especially
in Europe, lower capital flows, and rising global interest rates, post-crisis economic growth in many
countries, including Romania, will be moderate. We conservatively forecast our economy's medium-term
growth at around 3 percent. This will slow Romania's convergence with the EU average compared to the
pre-crisis period. It will also make it more difficult to ensure robust improvements of living standards of our
citizens, especially the poor.
We understand that to reduce macroeconomic vulnerabilities in this uncertain environment, we must
continue to strengthen our macroeconomic policies. To this end, we plan to reduce the ESA-based structural
deficit in line with the adjustment path for the medium term objective under the EU's Stability and Growth
Pact (SGP). For 2014, we have approved a budget consistent with a consolidated deficit target of 2.2 percent
of GDP in cash terms. This target should allow us to increase the absorption of EU funds to ensure funding
for key pro-growth investments. We will also safeguard health and education spending means-tested safety
nets for improved well-being, opportunities, and support of all, including the poor.
Regarding inflation, Romania's annual headline inflation decelerated sharply last year and ended the year at
1.6 percent, at the bottom of our medium-term target band of 2.5±1 percentage point. This deceleration, in
addition to the behavior of core inflation (around zero since October), and the persistent negative output gap
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allowed the National Bank of Romania to lower the policy rate during September 2013-January 2014 by a
cumulative 75 basis points to 3.75 percent. As a result, average interest rates on new loans felt to a historic
low of 8.2 percent in November. Later in January 2014, we reduced the high minimum reserve requirements
with a view to gradually bringing them closer to those in the ECB and other EU countries. Looking ahead, to
keep inflation expectations low and given the risks of volatile international capital flows and food and energy
prices, our monetary policy stance will remain cautious, closely monitoring inflation developments and
assessing risks in close consultation with the IMF and EC as part of the inflation and the overall policy
consultation mechanism.
The Romanian banking sector maintains appropriate capital buffers, enhanced liquidity, and provisioning,
but still faces pressures from asset quality, foreign bank deleveraging and, potentially, new external shocks.
The capitalization of the banking sector remains strong at 15 percent at end-2013 with some differences
across banks. However, credit growth in real terms to both corporates and households remains negative year-
on-year at -6.5 and -2.7 percent, respectively, at the end of 2013. Non-performing loans (NPLs) ratio closed
the year at 21.9 percent compared to 18.2 the previous year, reflecting the difficult economic environment,
stagnant credit growth, and slow removal of fully provisioned NPLs from bank balance sheets. Total
provisions cover 90 percent of NPLs while the narrower measure (IFRS provisioning ratio without prudential
filters) increased to 67.6 percent at end-2013. The pace of foreign-owned bank deleveraging has accelerated
in line with the rest of the region but remains orderly with a parent funding decline of 30 percent since end-
2011. As a result, reliance on local funding has increased, especially on deposits. The risks from continuing
parent funding retrenchment remain significant, especially if credit demand recovers, although these risks are
mitigated by the lower prudential filters and minimum reserve requirements. The NBR will continue to
closely monitor and supervise the banking system and take any necessary measures to ensure that banks
maintain sufficient capital and liquidity, in light of the uncertain economic environment which could pose
further challenges with respect to asset quality, profitability, and parent funding retrenchment for most
banks. A recent top-down stress test performed by the NBR for the 2013 Financial Stability Report indicated
that under an adverse scenario with a prolonged recession and 20 percent depreciation the overall banking
system would remain resilient. We are also working to improve the laws on deposit insurance to transpose
new EU directives.
Our macroeconomic management has been recognized by the markets: Romania's sovereign euro spread fell
from 557 basis points in January 2012 to 241 by March 19, 2014. Credit rating agencies have reaffirmed our
investment grade (e.g., Fitch Ratings, Moody's) or improved our outlook (Standard & Poor). In January
2014, we have successfully issued, on favorable terms, the first 30-year U.S. dollar denominated Eurobond.
The Reform Program
Our government is committed to continuing the strong reform program announced after the recent
reconfiguration of our governing coalition in February 2014. This reform program marks the next stage of
Romania's reforms focused on improving our debt management, enhancing the effectiveness of our fiscal
management, increasing the performance of our state-owned enterprises, creating investment opportunities in
key sectors (e.g., energy), and improving the functioning of property and financial intermediation markets to
facilitate private investments and greater economic opportunities for all Romanian citizens. We are also
supporting measures to improve our business environment and the conditions for healthy entry and exit of
firms and firm innovation.
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i. Debt Management
While the external debt market has been tapped successfully, the domestic government securities market
needs further development. The secondary market trading is relatively low although growing while on the
primary market and the issuance of long maturities is rather limited, all of which raise the vulnerability to
external shocks and the rollover risk and limits cost-effective financing options to the government. The
reform focus has now shifted towards sharpening and improving the Debt Management Strategy (DMS) and
its operationalization via Annual Borrowing Plans (ABP) to make debt management operations more
predictable for the budget and markets (Prior Action #1). The National Bank of Romania has introduced in
March a fully electronic platform for the primary market while now efforts are channeled to connect this
facility to the debt management system in the Ministry of Public Finance (MOPF) in order to ensure a real-
time access to the primary market data (Prior Action #2). Following this, MOPF will arrange the launching a
new electronic trading platform to improve the price disclosure and functioning of secondary markets and
will issue legal and operational guidelines for liabilities management operations. In 2014, the MOPF will
also create a policy committee and technical implementation committee and will revise tasks assignments in
the General Directorate of Treasury and Public Debt (GDTPD) along functional lines. This new
infrastructure framework will increase the pre-trade and post-trade information. and will enhance market
liquidity by decreasing trading costs and thereby allowing increased trading volumes.
ii. Fiscal management
To strengthen fiscal management, the government intends to implement ambitious reform measures in tax
policy and administration reforms, and public expenditure management.
On the revenue side, the objective is to broaden the tax base and, where possible, use the opportunity
afforded by higher revenues to reduce tax rates on some of the most distorting taxes. For example, we would
like to reduce the tax-wedge on labor income, which would help employment, incomes, and work incentives
for the bottom 20 percent of the population. We are also aiming at modernizing our oil and gas taxation
regime to attract investments that would contribute to sustainable development, improved infrastructure, and
diversification. We are also working closely with the World Bank to modernize NAFA, our revenue
collection institution.
On the expenditure side, we are undertaking a number of reforms to our systems to limit fiscal risks, improve
expenditure management, enhance the quality of public spending and absorption of EU funds, and improve
social spending for the poor and vulnerable. With the help of the European Commission and the IMF, we are
introducing a firm commitment controls system, enhancing our consolidated fiscal reporting system,
improving fiscal transparency and strengthening management of fiscal risks - including those arising from
Public-Private Partnerships. We are also working on key pillars of our medium-term fiscal framework,
including: (1) increasing the results-orientation of our budget; (2) enhancing our public investment
management and EU funds absorption; and (3) improving the safety net policies underlying this key
spending. We are also improving our budget planning tools to strengthen the medium-term fiscal
framework.
We are concerned that the results achieved in previous years through the execution of public budgets do not
always reflect the resources allocated, as efficiency of public spending remains low. To address this problem,
we submitted amendments to our Parliament amending the Public Finance Law to empower us to improve
results-informed budget programs (Prior Action #3). We have further prepared a detailed plan to start
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piloting this approach in the ministries of health and education and plan to adopt the 2015 budget applying
the result based framework to the two pilot ministries.
We are also concerned that public investments are not prioritized following good international practice and
appropriate technical screening processes before they are included in the budget. As a result, ongoing
investment commitments exceed 30 percent of GDP and are expected to take close to 12 years to be
completed. Our priority is, thus, to improve budgetary planning and project prioritization, which will also
help to increase absorption of EU funds. To do this, we have established and staffed the Public Investment
Evaluation Unit at the Ministry of Public Finance. The government has also adopted an Emergency
Ordinance (#88/2013) naming MOPF as the secretariat for prioritizing public investment projects considered
significant (above Lei 100 million) , and has also recently approved the methodology for appraising and
prioritizing significant public investment projects. (Prior Action #4). We will reappraise the significant
projects according to the approved investment prioritization norms for the preparation of the 2015 budget.
For the projects co-financed from the EU funds, prioritization will be performed based on the EU
regulations.
Further, despite improvements, our social assistance spending is still fragmented, insufficient targeted,
resulting in unnecessary administrative burdens. The proportion of social assistance spending reaching the
poorest 20 percent of the population can be further improved, as spending is dominated by categorically-
targeted programs, while the share of means-tested programs in GDP shrunk (Household survey data
suggest this share was 62 percent during the January-March period of 2012 after adjusting for the
true population coverage of the means-tested programs). In this regard, we have started the
consolidation of the all means-tested programs -- the Heating Benefits, Family Benefits, and Guaranteed
Minimum Income program - into a single flagship anti-poverty program, the Minimum Social Insertion
Income Program (MSIP). Last year we eliminated unnecessary asset filters from means-tested programs to
increase their coverage of the poor, and increased their eligibility thresholds and/or benefit levels to mitigate
the impact of the increase in energy tariffs on the household sector. This year we expect to complete the
necessary legal framework and in 2015 the regulatory and technical work to allow the launch of the MSIP
program during 2016. In this regard, the Cabinet has established, through a Memorandum, an inter-
ministerial committee for the preparation of the MSIP program. The committee is tasked, inter alia, to
finalize the legislation that will consolidate the means tested programs and introduce a benefit formula that
will not penalize beneficiaries if they start to work (Prior Action #5). The committee, led by the Ministry of
Labor, Family, Social Protection and Elderly, plans to submit the draft legislation for Cabinet's endorsement
and further submission to Parliament in September 2014. To ensure the smooth implementation of the
legislation and the achievement of the goals of the MSIP program - reducing income poverty among the
poorest 20 percent of the population, while supporting the activation of work-able beneficiaries -the
committee, inter-alia, is estimating the budgetary impact of the new program, covering both the transfers'
component and its administrative costs. This will include the upgrade of the management information system
for social assistance programs - hardware and software - which we expect to be ready during 2015.
Spending on the three programs to be merged into MSIP has shrunk since 2010, in part due to parametric
reforms and in part due to improved compliance with program rules. We are thus making efforts to allocate
funding to the new program to expand its coverage of the poorest 20 percent as much as possible, especially
during the winter season.
iii. State Owned Enterprises
We started major reforms to address the drag that state-owned enterprises (SOEs) pose to our economy and
the burden they impose on our budget. In addition to aggressively addressing the issue of arrears build-up,
we are making efforts to introduce governance principles based on good international practice for the
appointment of the boards of directors and top management. In parallel we have attracted private investments
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in four energy enterprises via two secondary public offerings (SPOs) and two initial public offerings (IPOs),
including a successful IPO for Romgaz in November 2013, the largest state-owned enterprise by revenue.
We have also liquidated or restructured other SOEs resulting in a reduction of the total work force in SOEs
from 245,253 in December 2011 to about 230,992 at the end of 2013. This has not been easy - for instance,
with support of the World Bank's DPL-DDO, we placed into insolvency process one of the largest electricity
producers (Hidroelectrica) to restructure it and commercialize its energy production in a transparent manner
via the energy exchange platform OPCOM. To further improve the financial and economic performance of
the SOE sector we consider it important to improve the accountability of the government as an owner. In this
regard, we approved a Memorandum on State Ownership and Oversight sharpening the management of the
SOE national portfolio (Prior Action #6). It clarifies the responsibilities of line ministries and MOPF for
corporate governance, financial reporting, accountability and transparency, and monitoring and assessment
of SOE management. It also promotes good practices, including movement toward international financial
reporting standards (IFRS). This action would be followed up with the enactment of a full ownership policy,
based on Emergency Ordinance 109/2011 and the evaluation we will be carrying out over the summer.
iv. Energy Sector Reforms
We have also substantially advanced reforms in the energy sector aiming at: (1) implementing the EU's
energy acquis; and (2) attracting private sector investments and professionalizing management of SOEs to
secure energy supply and to export to the rest of Europe. The 2003 energy strategy - Road Map for the
Energy Field - guided the restructuring and liberalization process and Romania's accession to the EU in the
area of energy reform. In 2011, we resumed energy reforms and, a year later, the Parliament passed new
electricity and gas law and a law that restored the operational and financial independence of the energy
regulatory authority (ANRE) and empowered it to continue the energy market reform. ANRE completed the
liberalization of the nonresidential electricity market in early 2014 (Prior Action #8), and expects to do the
same for the nonresidential gas market by 2015. This means that wholesale electricity and gas prices for non-
residential consumers will be determined by market participants on the energy market. We are also
committed to support ANRE in the implementation of the gas Road Map and in particular in fully
liberalizing gas markets for non-residential consumers. We see this as a crucial step to attract new
investments in this important sector for our economy and for Europe. To further foster electricity trading
with Europe, our transmission company, Transelectrica together with the relevant authorities/entities will
take the necessary actions to complete the ownership diversification of the energy market operator
(OPCOM) and to reach an agreement with the foreign partners for coupling the Romanian electricity Day
Ahead Market with the markets in Hungary, Czech Republic, and Slovakia in early 2015. These policies will
be outlined in our forthcoming Energy Strategy, which also spells out the important investments that our gas
and electricity transmission companies are undertaken to ensure proper connection of our gas and electricity
grids with neighboring countries.
v. Property Markets
Livelihoods of our rural poor and marginalized communities in urban areas are impaired partly because of
our citizens and companies inability to mobilize their assets for investments. This is due to a lack of reliable
information on real estate property rights. The cost of first registration is prohibitive, especially in rural areas
where only 10 percent of real estate, compared with about 39 percent in urban areas, is registered in the
integrated information system for cadastre and land registration. Further, the land restitution process begun
in the early 1990s has not formally finished, causing further uncertainty about property rights. Finally, long
settlement proceedings for land restitution add even more uncertainty to the property market, which leads to
informality of the property transaction. Broadening the coverage of real estate registration is crucial to
improving the functioning of the property markets. To restart this process, we have granted greater financial
autonomy to our National Agency for Cadastre and Land Registration (ANCPI) for carrying out the
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investments related to systematic registration of the property in the integrated information system for
cadastre land registration (Prior Action # 7). We have also started to draft a new Land Registration Law and
ancillary regulations to address the legal constraints that hinder systematic registration properties and expect
to complete it by early 2015. In this new framework, we would further develop an appropriate governance
and accountability framework of ANCPI, its management and its board. We are committed to ensure that the
sole focus of ANCPI is on extending the coverage of property registration, and will do so with a special
focus on territories with vulnerable population and in a gender-responsive manner in close consultation with
the World Bank and the European Commission. We would also avoid diverting registration resources of
ANCPI to territorial government or local units. We will fund our land restitution commitments from other
revenue sources.
vi. Deepening Financial Intermediation
Romania's growth depends critically on a financial sector that is stable, resilient, and deep enough to
efficiently intermediate savings and investments. To deepen financial intermediation we are focusing, in
addition to the issues mentioned under the banking sector remarks above, on removing obstacles for the
further development of our capital markets. Our strategy in this respect is three-fold: (i) promoting
privatization and investment financing of SOEs through the stock exchange and we are, as previously
discussed, revamping our domestic government securities market to provide key benchmarks for investors;
(ii) revising our regulations to remove barriers to increasing market participation in the equity and non-
government bond markets; and (iii) improving the governance of the recently unified regulator of pensions,
insurance and capital markets.
We are aware that improving the functioning of capital markets will allow the growth of our economy to rely
more on domestic savings and foster the development of tradable sectors. Government's strategy to
development the securities market focuses on the non-government fixed income market (with long
maturities), asset backed securities and collective investment schemes, and on establishing at the same time a
framework (and capacity) to supervise and enforce market integrity in all these areas taking into account
macro prudential considerations.
The Financial Supervisory Authority (ASF) is facing institutional challenges in swiftly completing the
integration of the former three supervisory authorities. The corporate governance of this agency was not set
up properly from the start, and this has required strong corrective action by the government and Parliament.
In this regard, we introduced a basic framework for corporate governance in the ASF, by reducing its board
size and establishing qualification and conflict of interest criteria for both board members and staff (Prior
Action #9). In parallel, in accordance with the conditions laid out by the Memorandum of Understanding
concluded with EC the selected consultant will deliver in April 2014 a report containing recommendations
on the ASF internal organization. Based on these recommendations, ASF will decide on the adjustments to
the organizational chart and on the assessment process for the rest of the staff. A new chairman has been
recruited following strict merit-based criteria. The chairman, his management team, and the Board will be
tasked with three strategic objectives: (1) further improving the governance and accountability framework of
the agency including: clarifying the broad agency objectives; board and management accountabilities;
enhancing transparency and public disclosure in general; and bringing all fees and charges to supervised
entities and market participants in line with international best practices; (2) developing a blueprint for the full
integration of the three previous supervision agency (including overall staff reductions as well as
reassignment of post with emphasis on off-site consolidated supervision); and (3) developing our country's
official strategy for developing the capital markets. The development of the securities market should include,
among others, the non-government fixed income market (with long maturities), asset backed securities and
collective investment schemes and, at the same time, should establish a framework (and capacity) to
supervise and enforce market integrity in all these areas. It should also take into account macro prudential
consideration. In the meantime, we are working closely with stakeholders towards the modernization of the
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Capital Markets Law and other pieces of legislation as might be appropriate to address constraints that are
hampering the development of capital markets.
vii Business Environment and Competition
We recognize that enhancing competition and harmonizing the institutional framework for competition with
EU principles will reignite productivity growth in Romania. Although our country provides significant
investment opportunities, our business environment is still challenging for small and large firms alike. To
improve the business environment, we will reduce a number of small "nuisance" taxes and fees and ease the
compliance process and are committed to improve the quality of the regulatory environment, by moving
towards systematic evidence-based policy-making, aligned with the EU Smart Regulation strategies. The use
of Impact Assessment (IA) has been highlighted as one of the key topics of focus and reducing the
administrative burden for the private sector is a key goal of reflected both in the Partnership Agreement with
the EU for the period 2014 -2020 as well as in the National Reform Program of Romania. In parallel our
Competition Council has embarked on an institutional reform program to increase its effectiveness on
promoting and enforcing market competition, including the elimination of anticompetitive sectoral
regulation. The Government plans to enact a revised competition policy legal framework in the areas of
unfair competition, state aid and competition law.
Program Management, Monitoring and Evaluation
The Ministry of Public Finance, as representative of the Borrower will facilitate the overall coordination of
policies through the coordination committee established pursuant to the Prime Minister Decision and chaired
by the Minister Delegate for the Budget.
In closing, I strongly believe that the World Bank can provide valuable support to the Romanian
Government's reform program for improved growth prospects and standards of living for our citizens. The
World Bank's financial assistance in the form of the proposed DPL loan series and technical expertise will
critically help fulfillment of the program's objectives. Our program has also been extensively described in
the Letter of Intent and associated Memorandum of Economic and Financial Policies signed with the
International Monetary Fund and in the Memorandum of Understanding signed with the European
Commission.
Signed in Buchare t on
By                             2014
Liviu Voinea
Minister Delegate for Budget
World Bank Governor
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