ECONOMY

Romania urged to spend less over fears tax cuts could fuel price rises

BUCHAREST – Romania needs to tighten its 2005 budget further than planned to counter looming inflation pressures and must plug the hole caused by sweeping tax cuts, the International Monetary Fund (IMF) said yesterday. The European Union candidate’s new centrist government has pledged to stick to its deficit target of 1.5 percent of gross domestic product and to make up for an estimated revenue shortfall of 1.3 percent of GDP from its new flat tax regime. But a senior IMF official said hefty public sector pay increases and anticipated further interest rate cuts meant the government may have to do more to keep prices in check. «We see that a tight fiscal position in 2005 will be necessary,» IMF resident representative Graeme Justice told Reuters in an interview. «Probably tighter than the 1.5 percent of GDP that was approved for the 2005 budget.» «We cannot have a large tax loss at this point and we have to find some way to offset it in the budget,» he added. Justice said Romania’s plans to open up its leu deposit market to foreigners meant the central bank will be forced to discourage speculative flows with lower interest rates. «Monetary policy is very much constrained by the capital account liberalization and so it’s inevitable for the central bank that it has to reduce interest rates,» Justice said. «That leaves fiscal policy (to fight inflation).» Hefty public sector pay increases granted ahead of November parliamentary elections have also added to price pressures. The new government of Prime Minister Calin Tariceanu introduced from Jan. 1 a flat 16 percent corporate and personal income tax, replacing a 25 percent rate and an 18-40 percent scale respectively. It delayed a promised cut in social security contributions, doubled taxes for small companies and dividend tax for individuals and pledged to get tough on tax evasion to make up for the expected revenue shortfall. Justice said, however, more measures may be needed to plug the budget hole. Soundness the key IMF experts will start discussing with the government on January 26 additional steps such as increasing the value-added tax, currently at 19 percent, and excise duties on some products such as petrol and tobacco, he said. He said that even though the central bank could try to prevent speculative swings after liberalizing capital flows with administrative measures, a sound economic program was the best defence against excess volatility. «We want to agree with the government a macroeconomic package which prevents that. A stable macroeconomic environment which will hopefully keep capital in Romania,» he said. It was paramount for the EU hopeful, which wants to join the bloc in 2007, to cap inflation this year at 6-7 percent and its current account deficit at 6 percent of GDP after it missed its targets last year. Inflation at the end of 2004 was likely at 9.3-9.4 percent, above the 9 percent target, while the current account shortfall is expected at 6 percent of GDP, above the 5.3 percent target agreed with the IMF, Justice said.