​Investors in Romania typically expect a bumpy ride when it comes to the tax regime, with frequently changing rules often motivated by political considerations. But the last few weeks have been exceptionally turbulent, even by Romanian standards, with shock announcements and U-turns making it virtually impossible to make sense of what the new fiscal landscape is going to look like.

It started on May 29, when Romania’s prime ministerial nominee Mihai Tudose outlined a list of radical fiscal changes to the parliament before being voted in by MPs as the country’s new premier. Yet in less than a month, top officials from the government and the ruling Social Democratic Party (PSD) have backtracked on almost all the proposals set out in Tudose’s speech.

The changes were all the more unexpected since Tudose was broadly expected to continue the policies of his predecessor Sorin Grindeanu. Both men had been appointed by the ruling PSD/Alde coalition, since the PSD’s leader, Liviu Dragnea, was unable to take up the post due to having a criminal conviction. Since Grindeanu was ousted by the PSD for failing to carry out its ruling programme quickly enough, the last thing anyone expected was for the party to tear up large parts of the programme and replace them with something completely new.

Among the changes announced by Tudose were a “solidarity tax” on high earners, a global income tax and the replacement of the existing profit tax with a turnover tax — the last one in particular caused an outcry from groups representing major investors.

The American Chamber of Commerce (AmCham) in Romania slammed the lack of consultation before the measures were announced, and claimed in a June 30 statement that they would “reverse the country’s macroeconomic performance, and isolate Romania from an investment perspective”. In a similarly strongly worded statement, the Romanian-German Chamber of Commerce and Industry (AHK Romania) said they posed “a real threat to the stability and predictability of economic policies”.

Having not taken the business reaction into account, the government’s reversals and U-turns started immediately. Indeed, Romania's new Finance Minister Ionut Misa announced plans to scrap the second pension pillar on June 29, only to contradict himself a few hours later. Another rapidly reversed policy announcement came from prime ministerial adviser Eugen Teodorovici who was sacked after just five days in the job after recommending a tax on the Orthodox Church.

Four weeks on, the turnover tax is also on the cutting room floor, with Tudose telling EU officials on July 11 that Bucharest was no longer planning to introduce the tax. At the same time he sought to reassure them that, “We are predictable in terms of financial-fiscal system” — wishful thinking under the circumstances.

The previous day, Dragnea had announced that the minimum wage would be raised to just RON1,550 (€339.2) as of next year and not the RON2,000 as envisaged in the recently updated governing programme. More recently, another senior PSD official, Marian Neacsu, told journalists that the solidarity tax would not be introduced because the damage to the government’s public image would outweigh any financial benefits.

While it looks like many of the measures that initially dismayed investors are now off the government’s agenda, it remains unclear what — if anything — will be proposed to take their place, leaving businesses in Romania in a state of ongoing confusion.

“Fiscal volatility is the hottest topic in Romania, along with the strong growth dynamic. The additional measures were a surprise and now there is some backtracking because steps like the turnover tax, for example, didn’t make much economic sense,” Andreas Schwabe, senior economist CEE at Raiffeisen Research, told bne IntelliNews.

"As the President [Klaus Iohannis] has said, there has been a good amount of 'fiscal hopping' going on in recent weeks. Most of it, however, will remain at just that: 'hopping'," says Alfonso Velasco Tamames of the Economist Intelligence Unit, noting the retractions on both the turnover tax and the solidarity tax. 

"The changes announced by Mr Tudose remove some of the immediate problems surrounding proposals that were clearly unworkable. This is clearly positive news for investors with exposure to the Romanian market ... However, given that there is still a desire to capture a larger share of multinational's profits, corporations and investors alike should expect continued hopping and some biting in this regard (although far softer than that resulting from the original plans)," Tamames tells bne IntelliNews. 

"Overall, the announcement of radical changes to the tax system without proper evaluation and with an unrealistic time horizon for their implementation has brought an increased atmosphere of uncertainty and unpredictability to the business environment. Again, we believe that the largest downside risks for investors and corporations are unlikely to materialise given the risks entailed to economic growth. Some of the more moderate risks may materialise." 

This also leaves investors in the dark as to what Romania’s budget deficit is going to look like. The rising deficit as a result of the expansionary fiscal policies — both before and after the December 2016 general election — is a source of concern since it is taking place at a time of rapid economic growth.

According to the European Commission’s Spring Forecast published in May, Romania is set to have the fastest growing economy in the EU this year, with GDP projected to rise by 4.3%. While much of the rapid growth over the last year or so has been driven by consumption, recent data is encouraging, showing that exports have also started to accelerate, growing at double digit rates in April and May.

 

 

At the same time, however, the latest Eurostat data shows that Romania’s budget deficit is also rising the fastest in Europe, as Bucharest tears up conventional wisdom about the need to save at times of fast growth to have spare capacity for a crisis. The deficit is likely to exceed the 3% threshold this year, after which the country may be put into the European Commission’s Excessive Deficit Procedure.

“Our colleagues in Romania think the budget deficit will be around 3.6% this year, although there is still some uncertainty. In terms of possible European Commission sanctions, the rising deficit is not so dangerous as re-entering the EU Excessive Deficit Procedure would impact only in 2019, and one might get the impression, that Romania’s policy planning horizon does not extend that far ahead,” says Schwabe.

“More depends on what the government decides to do; there is talk about cutting public investments which from an economic point of view is not the best strategy. Allowing the deficit to go to 3-4% when the economy is booming, is also worrying from a risk perspective because there is not much fiscal manoeuvring space if an economic shock comes,” he adds.

Aside from the government’s spending and taxation plans, officials including President Klaus Iohannis have been talking about a significant shortfall in revenue collection in the first half of this year, which would put further pressure on the deficit.

Meanwhile, Capital Economics analysts argued in a July 14 report the proposed tax changes “suggest that the government’s focus has shifted away from fiscal loosening and towards fiscal tightening”. However, they add that, “even those policies that look like having any chance of being passed won’t be enough to prevent the budget deficit from widening further next year”. They anticipate that the government is likely to announce fiscal tightening measures; a failure to do so would, they forecast, result in a deficit of around 4.5%-4.8% of GDP next year.