Consumption increase as growth engine in 2015

National Statistics Institute, published mid-February 2016, preliminary GDP growth rate for 2015. The advance of 3,7% looks impressive although only an estimate which might suffer certain adjustments. In addition, European Commission forecasts a 4% increase of Romanian GDP in 2016. The question now is whether this performance reflects a genuine increase of the economy or is owed to certain favorable fiscal measures taken throughout 2015-2016 period which led / will lead to a consumption increase.

Noteworthy, in June 2015, VAT for food products was reduced from 24% to 9% which automatically determined an advance of the consumption. Moreover, salaries in the public sector have been applied an overall increase of 10% starting December 2015 after medical staff benefitting of a 25% growth of earnings from October 2015 and professors of 15% since December. And good news continues, with the new fiscal code applied from January 2016, VAT general level was decreased from 24% to 20%, tax on dividends was reduced from general rate of 16% to 5% for natural persons while the minimum gross salary on economy is planned to be increased with 19% from May 2016.

We are thus facing an avalanche of fiscal reduction and personal income growth for each Romanian which would ultimately lead to a strong increase of consumption, which in turn should produce more tax revenues, higher than those lost through tax reduction measures. This is a simple equation which would certainly work as such in a developed economy where local producers could absorb this rising demand. The question is whether Romanian economy is prepared to take its share of this consumers’ money surplus. According to the Government, apparently the calculations done by the Ministry of Finance indicate that the budget deficit will be maintained under 3% as agreed with the European Commission for 2016 in spite of all those fiscal relaxations and increase of salaries in the public sector.

Representatives of the National Bank of Romania have recently expressed serious concerns on the sustainability of such growth rates on medium term. Their opinion is that GDP growth of about 3.5% – 4% was achieved due to the advance of consumption due to the 9% reduced VAT for food products, to salary increases and to ever reducing bank interest. NBR representatives fear that in the near future the effect of all those fiscal relaxations and salaries increases will melt and stimulating the economy through fiscal measures will stop. Then, the wind will blow in reversed direction leading to excessive budget deficit. Currently Romania is spending 1,6% of GDP on financing public debt and if this debt will go higher than we would need to cut spending from health, education, defense etc.

Thus, it is important to note that if Romanian economy should not rely on internal consumption for GDP increase, then the alternative would be to push the exports, consequently relying on foreign consumption for its growth. But what does this mean? It means first an increase of investments level be it domestic or foreign. It’s a fact that the budget deficit in 2014-2015 remained under 3% because the Government did not implement the investments as planned. The absorption of EU funds had been a total failure therefore co-financing was not anymore needed. The irregularities found in public acquisition put a halt in many major local public investments project while at national level, the political disputes and government reshuffling have determined the postponement of any major infrastructure project.

It would be difficult to rely on local capital for increase of exports. During past 25 years there has been little opportunity for a Romanian class of true entrepreneurs to emerge, corruption and lack of a functional judicial system plagued the business environment. In addition, the largest exporters are by far foreign companies therefore, as usual we would need to rely on foreign investors in order to increase our exports. Minimum salary will go higher starting May 2016, it will in premiere reach 1 Euro/hour. Would it be possible to still be attractive if the employees will be more expensive?

The response is affirmative, if the same employees will become more competitive or if the business environment overall will be more competitive. This means that Romania could not afford anymore low cost jobs, our salaries will be too high for those. But we cannot all be software programmers or car engineers which leads to the necessity of establishing reliable professional schools where people can acquire high level skills in partnership with the industry and as a response to the demand coming from labor market. This also means that employment level will have to go up with more unemployed people especially from rural areas and from Eastern part of Romania become active on the labor market.

And above all those, we would need an infrastructure to support private investments which in turn would boost exports such as fast transport connections between borders, a strong educational system at all levels, a reliable medical care network. Otherwise we will all remain stuck into the idea that there are outside forces which want us underdeveloped.

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