Summary:KEY ISSUES Background: Romania has in large part reduced internal and external imbalances through sound macroeconomic policies. However, income convergence with the EU has been slow and weak public infrastructure has emerged as a bottleneck for faster growth. At the same time, Romania remains vulnerable to external shocks and the repair of balance sheets is not yet complete. Policy recommendations: Going forward, sustainable macroeconomic policies need to be combined with measures that boost the efficiency of public spending, reinvigorate delayed state-owned enterprise (SOE) reforms, and resolve crisis legacies in the financial sector. • Fiscal policy. Maintain the fiscal adjustment achievements, put public debt on a firm downward path, ensure provision of higher quality public infrastructure, and improve revenue administration and public expenditure management including through higher absorption of EU funds. • Monetary policy. Keep the easing bias as inflation has fallen below the target band and support a private credit rebound. Improve the policy framework by gradually moving to full-fledged inflation targeting. • Financial sector. Maintain the intense watch on the banking system focused on asset quality and non-performing loans reduction, further strengthen non-bank supervision, develop capital markets, and create effective insolvency frameworks. • Structural reforms. Improve financial performance and generate resources for investment of SOEs by implementing good governance principles, restructuring and increased private ownership; further deregulate energy markets. Outlook and risks: Staff expects sustained growth supported by strong domestic demand. Better EU funds absorption could boost the growth potential by about ½ percent annually. However, increased volatility in the external environment and failure to implement a much needed infrastructure upgrade present downside risks.
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