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Public finances and the economy: how are we going through corona crisis?

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The economic crisis caused by the coronavirus pandemic has significantly affected the stance of global public finances, following years of solid economic growth, when public budgets have been generally placed on a consolidation path. At the end of 2019, 17 Member States of the European Union recorded budget surpluses. The others, with only one exception, recorded budget deficits below the 3 percent threshold according to the nominal convergence criteria.

The exception was right Romania, where, under the ruling of the Social Democratic Party, fiscal policy was highly pro-cyclical and opposite to economic responsibility – by recording high deficits in times of high economic growth. Therefore, Romania ended 2019 with the largest budget deficit in EU, of 4.4 percent of GDP, in the wake of a government leaving behind numerous bills and overdue payment obligations to the private sector.

The COVID-19 outbreak has generated almost simultaneously and consistently the need to raise health spending and provide broad-based fiscal stimulus to assist the most severely hit economic sectors - through direct support measures and tax and financial incentives. This has led to an unprecedented increase in public deficits for all Member States, given the general “lockdown” and the unfolding global economic fallout.

The stance of EU public finances deteriorated sharply, and the budget surpluses of the previous year have turned into large deficits overnight. The chart below shows the surge in budget deficits of EU countries, facing an unprecedented economic decline: by double digits in the second quarter for most of the Member States.

The budget deficit estimated by the latest budget revision places Romania in the upper half of the European ranking. We must remember however, that Romania had the worst starting point, with the largest budget deficit in EU at the end of 2019, hence the deterioration of public finances is not comparable to other EU countries.

In this regard, if we consider the change in the budget deficit relative to 2019, Romania ranks in the lower end of the range, alongside with Bulgaria and Sweden, with a deterioration of about 4.7 percentage points relative to the budget deficit as a share of GDP in the previous year.

Given the similar measures adopted by almost all EU countries  in response to the corona crisis - technical unemployment, deferral of some tax liabilities and financial support for the businesses - it appears that the deterioration of public finances in Romania was not one of the most aggressive.

Romania moves from the largest deficit in 2019 to one of the most moderate fiscal loosening in 2020. This mild ‘slippage’ indicates both the effectiveness of the stimulus measures and the favorable economic dynamics.

EU numbers for the third quarter show that all Member States recorded strong GDP growth rates, some even by double-digits, a rebound compared to the second quarter of 2020 when European economies bottomed out due to the hard lockdowns imposed by the health crisis.

Romania’s Q3 GDP increased by 5.6 percent on the previous quarter, with agriculture dragging down the quarterly dynamics. Accordingly, for the first three quarters, we notice a decline in seasonally adjusted GDP of only 4.6 percent. If this scenario confirms, Romania would be placed among the good performers in EU, given the challenges posed by the deeper than expected corona crisis.

The industry’s positive pace in the recent months is a good signal for recovery, which needs to be further supported through investment in infrastructure and absorbing European funds in the Recovery and Resilience Plan (PNRR).

Construction and service will be the sectors that will soften the decline in annual GDP in the last months of this year.

Even if the quarterly economic rebound was not as swift as the initial expectations for the third quarter - the economy is gradually recovering and there are favorable premises for a robust economic growth starting 2021.

Given that agriculture’s contribution to GDP is fading out in the last quarter and industry will continue to perform, the decline in this year’s GDP will be swiftly recovered, as the health crisis will be mitigated.

If current projections are confirmed, even within a certain margin, we can say that Romania has passed 2020, the year of corona crisis, having both a moderate economic decline and a moderate deterioration in the budget balance. Such a scenario outlines the rational starting grounds to strengthen the economy and public finances in the years to come.

Therefore, Romania needs, perhaps more than ever, responsibility and strategic vision, in order to place itself on a development path that will bring us significantly closer to the European Union average, through real sustainable convergence. In this regard, right-wing policies - focused on investment, innovation, competitiveness and economic responsibility, will truly support Romania's development.

We have two key directions: European funds and structural reforms!

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Cosmin Marinescu