EU-funded investments are supporting activity. With private demand subdued in the face of high interest rates, cost pressures and policy uncertainty before elections in 2024, large infrastructure projects are providing a backstop to growth in Romania’s economy.

Real GDP is projected to grow by 3.1% in 2024 and 3.3% in 2025, slightly below potential. Still-recovering foreign demand will limit near-term export gains. Pension increases will support household incomes, but higher taxes will weigh on private consumption. Unemployment will remain above pre-pandemic rates. Domestic cost pressures will diminish and import price growth will continue to slow. By 2025, headline consumer price inflation will fall to 3.7%, close to the top of the target band (Table 1).

There are important risks to the outlook. Strong core inflation could prove harder to tame than the projections assume. A prolonged period of high interest rates could cause an economic downturn and significant job destruction. Escalation in regional geopolitical tensions could further weigh on demand. In contrast, fast and effective deployment of the significant EU funds at Romania’s disposal would buoy activity now and lift future productivity and living standards.

With inflation well above target, the National Bank of Romania kept interest rates high in 2023. Romania’s fiscal deficit remains wide. Budget consolidation must continue to better align the stances of fiscal and monetary policy and put the public finances on a sustainable long-run track.

Monetary policy should remain tight. Strong recent growth in services prices suggests the policy rate will have to be kept high in 2024. Tighter management of liquidity may also be needed if high core inflation proves hard to subdue.

Recent strong growth in euro-denominated borrowing has moderated. Banking sector indicators are healthy. Large interest-rate differentials with the euro area and a relatively stable exchange rate encouraged firms to take on more euro-denominated debt from mid-2022. Borrowing based in foreign currencies has since moderated following ECB rate rises in 2023. But authorities are rightly monitoring FX-related risks to financial stability.

Prudent fiscal policy is needed to rein in demand and ensure public debt sustainability. Near-term limits on government expenditure aim to reduce current budget imbalances. Yet defence commitments, and rising outlays on pensions, education, health and social protection will increase spending pressure in the years ahead. The challenge for policymakers is to put the public finances on a sustainable track without derailing income growth or exacerbating inequality.

Efforts to contain growth in public spending should continue. Attempts to curb public workers’ remuneration in 2023 triggered widespread protests, prompting the government to backtrack. Containing growth in the state payroll remains important but should not compromise public administration. Spending reviews can help identify efficiencies while preserving service capacity.

Public pension reform is continuing. Population ageing will accelerate in the next decade, increasing the number of retirees as the pool of pension contributors shrinks. A planned recalculation of public pensions will increase near-term fiscal costs. But parallel reforms to lift pension ages will improve the system’s long-term financial sustainability. Keeping the pension system viable will also require Romanians to contribute more to their own retirement incomes, including recipients of special occupational pensions.

Romania must raise more tax revenue with less distortion to economic activity. Much of government revenue comes from distortive taxes on wages. High social contribution rates deter low-skilled workers from formal employment in a country with a large grey economy and widespread tax evasion. Tax concessions benefiting workers in IT, construction and agriculture further narrow the income tax base while a low‑rate microenterprise tax gives small firms a way out of Romania’s corporate income tax system. New measures aim to shrink tax loopholes and strengthen enforcement. But more must be done to improve the tax system’s fairness and efficiency.

Ongoing regulatory reforms will support investment. But more can be done to remove barriers to efficient reallocation of resources.

Corruption and weak competition in some sectors hinder efficient resource reallocation. Romania is making progress simplifying business registration and licencing, reducing firms’ costs. Continuing governance reforms would further improve the business environment, including by strengthening management and oversight of state-owned enterprises, which distort competition in industries they dominate. Improving market efficiency and stimulating investment also depends on continuing to combat corruption.

Greater financial inclusion could boost investment and living standards (Figure 2). In much of Romania access to credit is poor, limiting firms’ growth potential. Excessive court involvement in foreclosure proceedings discourages asset-backed lending. For firms unable to get bank loans, regulators could do more to open avenues to non-standard financing, including through the warehouse receipt system. Improving financial literacy could expand economic opportunities in Romania.

Disparities in socio-economic outcomes remain wide. Gaps in social protection left many people vulnerable when inflation surged. More can be done to encourage formal employment, including among women.

To be ready for future crises, Romania must strengthen the social protection system. Social assistance should be improved over time and access to health care expanded. Better education is the surest way to boost opportunity and reduce poverty. Tackling disadvantage in rural and Roma communities demands better basic infrastructure and improved access to social services.

Too many working-age women are outside the labour market. Policy settings contribute to low workforce participation by women and older Romanians. Generous parental leave encourages mothers to step back from work to care for children. Childcare shortages make it harder for young families to keep up two jobs. Later in life, low pension ages encourage women to retire early, reinforcing expectations for many that their time in work will be short. Reforms are needed to support female employment, and to better utilise Romania’s human capital potential.

Romania is not yet on track to reach its target of eliminating net greenhouse gas emissions by 2050. Structural change in the past three decades saw big emission reductions. But progress has stalled recently (Figure 3). Without faster abatement, emissions will increase with economic growth.

Fossil fuel dependence, an old car fleet and poorly insulated buildings increase emissions. Fuel subsidies and price caps mute incentives to save energy. To accelerate abatement, and limit impacts on living standards and vulnerable communities, efficient and fair policies are needed, backed with good governance. In addition to green investment, and effective regulations, Romania should make more use of market-based mitigation measures, including carbon pricing.

Decarbonising Romania’s economy depends on cleaner power, and more of it. A good share of electricity comes from renewables and nuclear (60% in 2022). But from a strong head-start, low-carbon additions to Romania’s power supply have stalled. Barriers to renewable energy investment are multiple, from price uncertainty, to clunky permitting, and unclear rules on land use. The biggest supply-side problem is the power grid itself. These barriers must be addressed if Romania is to replace coal power, and fossil fuels for transport and heating, with clean electricity. Building and transport emissions are rising. Progress improving building energy performance and switching to cleaner heating fuels has been slow. An expanding fleet of old cars has lifted road transport emissions. Electrifying heating and vehicles will help curb emissions from homes and transport. For the building stock, large investments are underway to improve energy efficiency. Better targeting of state support would help reduce the fiscal burden. Transport policies remain too accommodative of cars. Price signals and better planning can encourage walking, cycling and more use of public transport.

Romania is vulnerable to climate change. Planned investments will strengthen resilience to natural disasters, such as floods. But better prevention is also needed, including to limit building in high-risk areas and to enforce strict construction standards.