Romania risks major fiscal slippage in 2025 after government passes new Pension Law

Romania risks major fiscal slippage in 2025 after government passes new Pension Law
Romania will hold presidential and parliamentary elections in 2024. / Arvid Olson via Pixabay
By Iulian Ernst in Bucharest November 10, 2023

The government of Romania has endorsed the new Pension Law, promoted by the Social Democrats (PSD), a bill that envisages 40% average pension hike in September 2024 and a significant impact on the public deficit in 2025, amounting to 3% of GDP. 

The impact of the law, if passed by lawmakers, will be moderate in 2024 but will leave the new government formed after the general elections next year with a major problem. 

The new government will thus have to either defer the pension hike — a cumbersome task as the hike is scheduled for September 2024, most likely before the new government is formed — or increase taxation overnight in early 2025, with the VAT rate hike at the top of the list that also includes higher property taxation. The inflationary impact is the least Romania’s economy would suffer.

There is a third possible but highly unlikely scenario though: the scenario of successful fiscal reform pushing up the budget revenues (transfers excluded) by some 3% of GDP to a decent level of 30% of GDP in 2024.

The target is highly feasible in principle, but Romanian governments, irrespective of their political orientations, have performed pretty weakly on such matters, particularly during electoral years. On the other hand, the fiscal administration cannot remain forever at the primitive level it is now, and the tax collection will sooner or later improve.

The Liberal (PNL) Finance Minister Marcel Bolos has been more cautious than his partners in the PSD and, at the last minute before the endorsement of the Pension Law by the government on November 9, expressed serious doubts related to the sustainability of such a bill.

In brief, the Ministry of Finance warned that the bill would prompt major fiscal slippage in 2025 unless Romania improves revenues significantly  — by 1.8% of GDP to offset the effects of the Pension Law alone. Bolos outlined six prerequisites for the government, which would put Romania’s fiscal system in line with those of other European states.

Under the no-reform scenario, the fiscal gap would reach 6.1% of GDP in 2025, the finance ministry warned – twice the 3% target the European Commission expects to let Romania exit the Excessive Deficit Procedure. 

Politically, the reserved opinion expressed by the Liberal minister of finance places the hot potato in the hands of the Social Democrats, who, however, might seek short-term electoral dividends. In fact, it is not totally unlikely that this conflict between the ruling coalition’s members is aimed at maximising the aggregated electoral score of the incumbent ruling coalition, which is expected to survive the general elections next year.

Liberal voters are more inclined towards pro-business policies and lower taxation, while the Social Democrats’ electorate attaches particular importance to the topic of pensions (and social protection in general). 

However, the endorsement of the Pension Law by lawmakers would set in place a risky mechanism that has to be addressed by the new government after the general elections next year. The deadline might seem remote, from a political perspective, but it is rather tight and will leave the new government with a minimal number of options.