George Serban

Bucharest, April 24, 2009
Mr. Dominique Strauss-Kahn
Managing Director
International Monetary Fund
Washington, DC 20431
Dear Mr. Strauss-Kahn:
1. Economic conditions in the region have worsened sharply in recent months as a result of the global financial crisis. These events were aggravated by underlying imbalances in our economy, and have resulted in sharply deteriorating prospects for Romania. In response, the
government and the National Bank of Romania (NBR) have developed a comprehensive
strategy to firmly anchor macroeconomic policies and reduce financial market stress. We
request that the Fund support our program through a Stand-By Arrangement (SBA) for a
period of 24 months in the amount equivalent to SDR11.443 billion (€12.95 billion). In
conjunction with support of €5 billion under the EU’s balance of payment financing facility
and other multilateral commitments of some €2 billion, this arrangement will signal the
international community’s support for our policies. We view this package as essential to
protect the Romanian economy from the worst effects of the worldwide crisis, and to put us
in a position for a strong return to growth once the current difficulties ease.
2. We have discussed with IMF staff our economic program, which is outlined below.
The program aims to cushion the effects of the sharp drop in private capital inflows while
implementing policy measures to address the external and fiscal imbalances and to strengthen
the financial sector. The immediate objective is to facilitate an orderly adjustment of the
external deficit, thus easing excessive pressures on the exchange rate which could otherwise
cause severe balance sheet effects on the corporate and household sectors, resulting in a
sharper recession and strains in the banking sector. To attain this objective, our program
intends to: (i) strengthen fiscal policy further to reduce the government’s financing needs and
improve long-term fiscal sustainability, thus preparing Romania for eventual entry into the
euro zone; (ii) maintain adequate capitalization of banks and liquidity in domestic financial
markets, (iii) bring inflation within the NBR’s target range and maintain it there; and (iv)
secure adequate external financing and improve confidence.
3. The government has already made important efforts to bring about the needed
adjustment to stabilize the economy. We approved a 2009 budget with important spending
cuts and revenue increases yielding around 3 percent of GDP. As prior actions under the
program, another 1.1 percent of GDP in fiscal consolidation measures will be implemented.
2
An anti-crisis plan has been launched, including efforts to reorient public spending toward
investment and to encourage private investment. Social measures to protect vulnerable
groups are also being undertaken. The NBR has expanded its liquidity support to bank and
several banks have boosted their capital adequacy while others are in the process of doing so.
4. The program will be monitored through quantitative performance criteria and
indicative targets, structural benchmarks and consultation clauses, during quarterly reviews.
Table 1 below sets out specific quarterly targets that are to be observed under the SBA for
the overall general government balance, the change in arrears for the general government,
CPI inflation, and net foreign assets, as well as for the issuance of new government
contingent liabilities on behalf of the nonfinancial private sector and public enterprises. In
addition, there will be indicative targets on the primary expenditure of the general
government, net of disbursements of pre- and post-accession EU structural funds. We will
have approved by emergency ordinance and sent to the parliament for ratification a package
of fiscal measures designed to yield 1.1 percent of GDP RON 5.9 billion before consideration
of our program by the IMF’s Executive Board. Final approval of these measures will be
required for the first review. The NBR will complete by April 30 (as a prior action) stress
testing of all banks with more than 1 percent share (by assets) in the Romanian market, plus
selected smaller banks, according to risk parameters agreed with IMF staff. The first review
of the program will take place by September 15, 2009 and the second review by
December 15, 2009. We believe that the policies set forth in this letter are adequate to
achieve the objectives of our economic program, but the Government stands ready to take
additional measures as appropriate to ensure the achievement of its objectives. Romania will
consult with the IMF on the adoption of these measures and in advance of revisions to the
policies contained in this letter in accordance with the IMF’s policies on such consultations.
Recent economic performance and macroeconomic framework for 2009–10
5. Romania experienced an economic boom from 2003-08 that led to overheating and
unsustainable imbalances. GDP growth averaged over 6½ percent per year, as foreign direct
investment and capital inflows helped finance high consumption and investment growth.
Robust export growth to EU countries reflected a process of increasing economic integration
with western European economies. However, import growth was even faster, generating
increasing current account deficits that peaked at 13½ percent of GDP in 2007. The
overheating economy and rapid capital inflows complicated monetary policy, resulting in
credit growth averaging 50 percent per year in 2006-7, and impairing NBR’s ability to
achieve its inflation target notwithstanding increases in interest rates and reserve
requirements together with other measures to slow credit growth. Fiscal policy was strongly
procyclical, with the government deficit rising from under 1 percent of GDP in 2005 to near
5 percent of GDP by 2008.
6. In recent months financial stress has increased, reflecting external factors and the
downturn in the economy. The extreme shift in investors’ risk preferences, which spilled
3
over from difficulties in global financial markets, has negatively affected the exchange rate,
equity prices, and the government securities market. Capital inflows have slowed sharply,
and NBR reserves have begun to decline. The effects in Romania have not been especially
pronounced compared with elsewhere in the region, but due to the weak fiscal position and
high current account deficit, the vulnerability to a sudden drop in capital flows is higher.
7. The economy turned sharply down in the fourth quarter of 2008, and prospects for
2009 are negative. GDP fell by 3.9 percent (q-on-q seasonally adjusted) in the last quarter,
and indicators suggest the decline is continuing in early 2009. At this time, the outlook is
particularly uncertain, as it depends on global events and on restoring consumer and investor
confidence. We anticipate a sharp drop in GDP this year, but are hopeful that the measures
proposed in this program will limit the fall. A recovery is expected to begin in 2010, but
growth is likely to remain near zero due to the lingering effects of the global downturn on
Romania. The risks to the baseline scenario are mostly on the downside, reflecting
uncertainty about the speed with which financial markets will stabilize and the depth of the
global economic slowdown. Inflationary pressures are expected to abate as the economy
turns downward, and we anticipate that CPI inflation will move to within the NBR target
band by late 2009 and remain there throughout 2010.
8. A current account correction appears well underway, but receding capital inflows are
opening a significant external financing gap. Gross external financing needs will decline in
2009, due to the smaller current account deficit, and will be partly covered by pre- and postaccession
EU structural funds (a stable source of inflows) and already committed foreign
direct investment inflows. We cautiously assume net outflows from the non-financial private
sector. Our IMF- and EU-supported program will strike a balance between balance of
payments adjustment and financing support. Once the program takes effect, we expect
foreign banks to largely maintain their exposure, stemming the decline experienced early in
the year. At the same time, we aim to gradually increase the NBR’s foreign reserves as a
precaution against unexpected outflows. The resulting external financing need of some
€20 billion over the period 2009-2011 can be covered by drawing on resources from the IMF,
support under the EU’s balance of payment facility, and from other official creditors.
Fiscal Policy
9. Government spending doubled between 2005 and 2008 in nominal terms, pushing the
public share of economic activity from 32 percent of GDP to 37 percent. The public sector
wage bill also more than doubled these three years due to high wage increases combined with
a large increase in government employment. The fiscal deficit rose in 2008 to about 5 percent
of GDP. In the final months of 2008, further expenditure increases in the run-up to the
elections were financed on a very short-term basis, as the government found itself unable to
borrow on longer maturities at reasonable cost. As the economy enters recession in 2009, an
easing of fiscal policy to cushion the downturn is unfortunately no longer possible. Spending
4
has become too high and financing conditions leave the government unable to finance a large
deficit.
10. The current government, which took office in late December, has already taken
significant steps to reverse the fiscal imbalance. The fiscal policies of 2008 would have
produced a deficit of nearly 9 percent of GDP in 2009, but measures already approved in the
2009 budget will reduce the deficit by about 3 percentage points of GDP. These budget
measures include: (i) an increase of 3.3 percentage points in social contributions; (ii) adjusted
property taxes due to an increase in appraisals; (iii) significant cuts in the public wage bill
through reductions of bonuses and other benefits, and the elimination of 137,000 vacancies
(previously used to grant higher salaries to existing staff); and (iv) substantial reductions in
goods and services spending, as well as in subsidies.
11. Under the proposed IMF-supported program, the government will undertake
additional fiscal adjustment efforts as a prior action, designed to bring the deficit down
another 1.1 percent of GDP to 4.6 percent of GDP in 2009. Primary government expenditure
(which excludes interest payments) will be reduced by an additional 0.85 percentage point of
GDP compared to the 2009 budget. This will be achieved by (i) foregoing public sector wage
increases (totaling 5 percent) scheduled for 2009 or equivalent further cuts in employment;
(ii) reducing public employment, including by replacing only 1 of 7 departing employees;
(iii) reductions in capital spending on items like vehicles and office equipment, plus a more
realistic timetable for EU supported investment projects; (iv) additional cuts in spending on
goods and services; and (v) further reductions in subsidies to public entities. Parliamentary
ratification of these measures will be completed by the first review of the program (structural
benchmark) Within the government’s expenditure envelope, we will give priority to
investment projects cofinanced by EU funds. We will also allocate an additional RON 250
million in spending to improving social protection for the most vulnerable groups during the
economic downturn. On the revenue side, measures to eliminate certain tax deductions and
allowances (in particular on company cars, and depreciation of revalued assets) are expected
to generate an additional 0.25 percent of GDP.
12. The program will be primarily monitored through the cash balance of the general
government (as defined in the accompanying technical memorandum, TMU) (a quarterly
performance criterion). In the event that nongrant revenues exceed those foreseen under the
program, the deficit target will be adjusted downward by one half the surplus, allowing for
additional capital spending while reducing the deficit further. We will consult IMF staff on
adjustments to the target and on eventual corrective measures in the event of a shortfall in
government financing. A performance criterion will be established on the change in domestic
payments arrears (as defined in the TMU) that will contemplate a full repayment of 2008
arrears under the program. In case of need, the government will take corrective measures to
prevent the accumulation of new spending arrears. An indicative target will also be
established on the primary expenditure of the general government, net of reimbursements
5
from pre- and post-accession EU structural funds, which will be subject to the same adjustor
as applied to the deficit target.
13. The government is committed to maintaining fiscal discipline in the long-term,
recognizing that this is a key element in reducing the external imbalance and in retaining
investor confidence. We therefore intend to continue budget consolidation in 2010. We
envisage a further reduction in the general government deficit to around 3⅔ percent of GDP.
Fiscal efforts will continue to be concentrated on the expenditure side. Specific quarterly
targets for 2010 will be set at the time of the second program review (to be concluded by
December 15, 2009). For 2011, we plan to move the general government deficit below 3
percent of GDP (under both national and ESA 95 definitions). Passage of a 2011 budget
designed to achieve this objective will be a structural benchmark for the sixth review of the
program (scheduled by December 15, 2010).
14. Sustainable achievement of lower budget deficits will require important changes in
the budget process, as well as reforms in revenue and expenditure policies. A key component
of our medium-term strategy will be a new fiscal responsibility law that will, among other
things: (i) set up, in coordination with the IMF and the World Bank, procedures for improved
multiyear budgeting; (ii) establish limits on budget revisions during the course of the year;
(iii) lay out fiscal rules on expenditures, public debt and the primary deficit; (iv) create a
fiscal council to provide independent and expert scrutiny; and (v) set up a framework for the
issuance and management of guarantees and other contingent liabilities. We plan to submit
this law to parliament and prepare an implementation plan by end-November 2009 (a
structural benchmark).
15. We have requested technical assistance from the IMF, the World Bank, and the
European Commission in 2009 to assist in improving public financial management, tax
administration, and the efficiency of public expenditures. Implementation of
recommendations from this assistance will be undertaken in 2009 and 2010, including
comprehensive reviews of the fiscal code and the fiscal procedures code in line with
European Commission deadlines and procedures. We will implement an improved system of
financial monitoring of decentralized fiscal entities (including public enterprises) and will
move to increase the net revenue from these entities through tighter control on their
expenditures and reduced subsidies. In 2010, once the enhanced monitoring is in place, an
indicative target on the financial balance of the largest public enterprises will be included in
program conditionality. Public enterprises will not be allowed to accumulate new arrears, but
they will have to restructure to reduce existing arrears. During the program period, public
enterprises making losses will not be allowed to raise compensation; those earning profits
will only be allowed to increase compensation in line with inflation and productivity growth.
We will step up efforts to improve the absorption of EU funds, while ensuring they target the
right growth priorities. Improving the efficiency and effectiveness of the public
administration will be instrumental to this goal.
6
16. We currently face major problems in the public sector wage system. Bonuses
comprise too much of total compensation, there is no unified wage scale, and there is a large
numbers of laws regulating wages in different parts of the system. To permanently eliminate
these problems, we will approve during 2009 legislation to restructure the public
compensation (structural benchmark). Under this legislation, we will establish a unified,
simplified pay scale, and reform the current system of bonuses. A ceiling of under 30 percent
will be phased-in on the share of all non-wage personnel expenditures as a share of total
public compensation. Creation of non-monetary bonuses will be prohibited. Monetary
bonuses will be consolidated—eliminating the large majority of bonuses or rolling them into
the base wage. For any given public servant, total bonuses would be legally capped. All
bonuses will continue to be fully taxable. The law could provide for a phasing-in period of
the reforms of up to 3 years, and efforts will be made to safeguard the real incomes of the
lowest paid workers during this process. Further attributes of this legislation will be
coordinated with the Fund and the World Bank.
17. A significant source of fiscal pressure over the medium term is the cost of future
pension obligations. To address this, we will reform key parameters of the pension system, in
coordination with the World Bank (structural benchmark). Changes will include moving
toward indexing public pensions to consumer prices rather than to wages and limiting the
scope for discretionary pension increases. Groups of public employees currently excluded
from pension contributions will have such contributions phased-in. We will also continue
gradual adjustment of the retirement age beyond the currently agreed schedule (particularly
for women) taking into account the evolution of life expectancies, to allow for greater
financial stability of the system, as well as to ensure that retirement parameters are more in
line with EU practices. To protect vulnerable pensioners, we will make efforts to boost
targeted poverty support programs that would improve their living standards. We will
continue to phase in the second pillar of the pension system, with regularly scheduled
increases in contributions as originally envisaged. Together, we hope that the pillars of the
pension system will allow us to eventually attain our objective of a 45 percent replacement
ratio for retirees on average.
Financial Sector
18. The Romanian banking system entered the period of global financial turbulence with
a strong solvency position. All 32 banks are in compliance with the capital adequacy
requirement of 8 percent, and the average capital adequacy ratio was 12.3 percent at the end
of 2008. Most banks are foreign owned (with 87 percent of assets), and most of the parent
banks are based in the Euro area, with access to liquidity through the ECB facilities. The
parents of the main banks operating in Romania have pledged any support necessary for their
subsidiaries, committing to maintaining their global exposures to Romania over the program
period, and to recapitalizing their subsidiaries as needed. This was reaffirmed in their joint
statement issued in Vienna on March 26, 2009. The NBR, in conjunction with home country
banking supervisors, will monitor this commitment closely.
7
19. While the banking system as a whole is currently well-capitalized, it now faces more
difficult macroeconomic and global financial circumstances than in recent years and
exceptionally uncertain prospects. In these circumstances it is prudent for banks to maintain
strong capital buffers. To this end, the program will take advantage of the high standards of
stress testing capability developed by the NBR. Stress tests of individual bank balance sheets
and lending portfolios under different scenarios will be used to assess the potential increases
in own funds needed to ensure that solvency ratios remain above 10 percent throughout the
program period (prior action).
20. Once stress tests are completed, banks will be required to secure, by the end of
September 2009, sufficient resources to cover any potential shortfalls revealed by the stress
tests. These resources could be provided either in the form of increases in share capital or
through subordinated long-term (at least 5-year) loans and similar instruments, qualifying as
tier 2 capital and convertible into ordinary share capital at the holders’ discretion or at the
request of the NBR. These resources should in the first place come from the owners of the
banks, but we will encourage bank owners to actively explore opportunities for cofinancing
the increase in stable funding offered by the IFIs in the framework of their February 2009
Join Action Plan in support of banking systems in the CEE region.
21. A temporary preferential regime will be established for banks whose majority owner
signs a commitment to (i) maintain overall exposure to Romania throughout the period of the
program; and (ii) increase the capital of its bank in Romania in line with the potential needs,
as assessed under the stress-testing exercise. For these banks, any new subordinated debt
subscribed either by the owners or by the IFIs would be exempt from the NBR’s reserve
requirements. For the purposes of monitoring compliance with (ii), this subordinated debt
and similar instruments would be counted as tier 1 capital, while existing capital adequacy
rules will still apply. This preferential regime will expire at the end of the program period. In
line with EU principles, it will be available to all banks established in Romania, regardless of
the nationality of the owners. Banks’ commitment to maintain or increase exposures and to
enhance capital as needed is a key element in improving financial stability and monetary
conditions. If monetary conditions evolve favorably, the NBR will be prepared to gradually
ease reserve requirements, which in turn will promote bank stability.
22. Although the banking system is currently stable and sound, we will amend our
banking and winding-up laws, in consultation with the IMF, to be able to respond in a timely
and effective fashion in the event of bank distress. A key objective of the amendments will
be to strengthen the special administrator’s ability to deal with banks in weak financial
positions (end-November 2009 structural benchmark). Beyond bank resolution, the NBR’s
remedial powers will be strengthened with provisions allowing it as part of its assessment of
suitability to request that significant shareholders increase their share capital and financially
support the bank, and to prohibit or limit profit distributions (end June 2009 structural
benchmark). We are cognizant of the need to streamline and strengthen our court-based
8
proceedings for winding-up of banks and intend to pursue further work in this area at a future
stage.
23. A further crucial ingredient in ensuring confidence in the banking system is the
system of deposit insurance. In 2008, governments across Europe, including Romania, acted
to strengthen their deposit insurance systems by raising the level of deposit coverage to at
least €50,000. To further strengthen the RDGF, and to bring it more closely into alignment
with international best practice and prospective requirements under EU directives, the RDGF
will supplement its existing funding with access to government privatization receipts held in
the Treasury account in the NBR (currently RON 11.6 billion). Additionally, procedures for
the activation of deposit insurance will be modified to simplify and accelerate payouts. Under
modified legislation, deposit insurance will be paid within the 20 working day period
authorized in the EU directive on deposit guarantee schemes (structural benchmark).
24. The NBR will continue to improve the banking supervisory and regulatory
framework, and will consult with Fund staff prior to the introduction of any new or revised
prudential regulations for banks. This will include more detailed reporting requirements on
liquidity and, at an appropriate time, raising the minimum level of the capital adequacy ratio
from 8 percent to 10 percent. We are also committed to bringing Romanian financial
accounting standards into line with international practice, as reflected in the International
Financial Reporting Standards (IFRS). Adopting IFRS will reduce regulatory burdens on
cross-border banks and corporations, and provide a more transparent framework for FDI. In
the current circumstances, however, a rapid transition could be disruptive, particularly in the
financial sector. In view of this, the adoption of IFRS will take place on a timetable to be
determined by the NBR.
25. We will seek an agreement with commercial banks to facilitate the restructuring of
household debt contracted in foreign currency by adjusting the maturity and repayment
schedule of the debt, including offering the option to voluntarily convert it in domestic
currency. Banks will also be allowed to continue to rely on their own in-house expertise for
the collection of their claims
Monetary and Exchange Rate Policy
26. The NBR is determined to gradually bring inflation down to the official target of
3.5 percent (plus or minus 1 percent). Under the program, progress towards this goal will be
monitored using an inflation consultation clause (see TMU). Monetary policy was tightened
in 2007 and the first half of 2008 in response to a rise in underlying inflationary pressures.
Looking forward, the economic slowdown in Romania and the rest of the world will likely
put downward pressure on inflation, but any further depreciation of the exchange rate could
boost inflation. Therefore, monetary policy will remain vigilant, with any easing of reserve
requirements or of the policy interest rate calibrated to assure attainment of the inflation
9
objective by end-2009, and with due consideration of the possible effects on capital flows
and the exchange rate.
27. Under the program, we plan for an increase in Gross International Reserves of 0 in
2009 (implying a recovery of all reserves lost in the months before the program takes effect),
and of €3.0 billion in 2010. This will provide improved confidence in the economy and allow
for greater reserve coverage of short-term liabilities. A performance criterion will be
established on Net Foreign Assets that is consistent with gross reserves accumulation
objective. Within the inflation targeting framework, the NBR’s intervention policy will be
applied consistently with the target for net foreign assets under the program. Reserve losses
exceeding €2 billion in any 30-day period during the program will trigger consultation with
IMF staff. The NBR will widen the range of assets acceptable as collateral for its facilities.
The NBR stands ready to further expand its toolkit as needed.
28. During the period of the Stand-by arrangement we will not, without Fund approval,
introduce or intensify restrictions on the making of payments and transfers for current
international transactions, nor introduce or modify any multiple currency practices or
conclude any bilateral payments agreements that are inconsistent with Article VIII of the
Fund’s Articles of Agreement. Moreover, we will not introduce or intensify import
restrictions for balance of payments reasons.
29. We recognize the importance of completing a safeguards assessment by the first
review under the Stand-By Arrangement. The National Bank of Romania will provide the
information required to complete the assessment by the first review and will receive as
safeguards mission from the IMF as necessary.
\s\ \s\
Gheorghe Pogea Mugur Isarescu
Minister of Finance Governor of the BNR
Attachments

http://www.imf.org/External/NP/LOI/2009/rou/042409.pdf