In a recommendation to be published on June 23 and proposed for endorsement in the July 8 meeting of the Economic and Financial Affairs Council (ECOFIN), the European Commission sets an updated fiscal consolidation trajectory for Romania, sets October 15 as a deadline for the annual update under the Excessive Deficit Procedure (EDP), and requires bi-annual updates instead of annual updates under the Excessive Deficit Procedure, Cursdeguvernare.ro reported. The updated fiscal consolidation trajectory and the tighter reporting calendar were prompted by Romania's fiscal slippage last year compared to the 7-year consolidation plan previously defined.

In line with the proposed recommendations, Romania will deliver an update by October 15 each year in addition to the regular update due by April 30. This year, in particular, the October 15 update may include a revision of the proposed trajectory under the very likely scenario that the plan proposed by Romania by July 8 (reportedly not including an increase in the standard VAT rate) fails to be observed.

The new fiscal consolidation trajectory requires a fiscal effort that Romania can not realistically achieve this year, but this should be addressed in the annual update Romania is expected to deliver before the July 8 ECOFIN meeting. To what extent the European Commission would accept spreading last year's fiscal deviation over a longer period depends on the credibility of the plan Romania is supposed to draft and submit by the July 8 meeting of ECOFIN. Presidential advisor Dragos Anastasiu said the ruling strategy, including the fiscal plan, would be revealed on June 23.

Under the draft recommendation inked by the EC on June 20, leaked in media and consulted by Cursdeguvernare.ro, the Commission sets annual nominal growth rates of 2.8% and 2.6%, respectively, for Romania's net expenditure in the years 2025 and 2026 – instead of 5.1% and 4.9% respectively under the recommendation endorsed by ECOFIN on January 21. This is to address the excessive rise of 19.9% in 2024, 5.6 percentage points above the recommended 14.3% increase.

Combined with revised macroeconomic projections, this would result in a real contraction of net expenditure of 3.1% in 2025 and 2.3% in 2026 (ignoring the marginal impact of real GDP growth). Under the previous recommendations, the net expenditures were supposed to rise in real terms in 2024 (but not as much as they eventually increased) and remain roughly constant in real terms in 2025-2026. 

METHODOLOGY: The (net or net-adjusted) expenditure benchmark is a complex benchmark set by the European Commission to conduct fiscal consolidation since 2011. The magnitude of its change reflects the fiscal consolidation through either cutting expenses or adding discretionary revenues while filtering out the effects of unemployment benefits or interest paid on public debt. The more negative the change is, the stronger the fiscal impact is. However, the conversion of the expenditure benchmark in fiscal consolidation terms (cash) is rather complex. 

The European Commission, in the draft recommendation, also notes that the reforms included in Annex II of the January 21 recommendation remain in place, in particular the Review of the Tax Framework – the reform with the strongest impact on the fiscal consolidation in 2025 when the ESA public deficit was planned to drop from 7.9% in 2024 (actual: 9.3% of GDP) to 7.0% of GDP. 

The specific reform's fiscal impact, including the impact of raising the non-taxable threshold for pension income (0.2 % of GDP), was 1.3% of GDP, and for this to be achieved in three quarters of the year, the annualised impact of the reform was calculated at 1.7% of GDP. 

In principle, if the new tax reforms are enforced as of July 1 (which is unrealistic), their annualised impact should be around 2.3% of GDP in order to achieve the 1.3% of GDP effect. However, this would still not offset part of last year's fiscal slippage (1.4% of GDP, specifically from the planned 7.9% of GDP to the actual 9.3% of GDP) that the Commission seeks to spread across three years under a front-loaded calendar. Offsetting even a third of last year's slippage would require fiscal corrective measures with an annualised impact of 1% of GDP, which would result in total fiscal corrective measures of over 3% of GDP. 

The convergence towards the consolidation trajectory leading to under-3% of GDP deficit in 2031 will be assessed by the European Commission by October 15, when deviations from the plan proposed by July 8 would result in sanctions.

Before the ECOFIN's October 15 decision, however, the rating agencies scheduled reviews for Romania's economy. Fitch is the first of them, on August 15. The fiscal plan to be delivered by the new Romanian Government by July 8 and further updates on the budget execution are therefore critical to prevent a negative action of the rating agencies, which would push the country's sovereign debt into the category not recommended to normal investment funds.

iulian@romania-insider.com

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