The crisis generated by the pandemic highlights the weak economic foundations.
An Euler Hermes analysis predicts that the Romanian economy will register the worst quarterly contraction of more than 20 years in the second quarter of 2020 and, moreover, a steady decline in GDP until the first quarter of 2021.
EU membership, a competitive industrial sector and an adequate business environment, together with fairly good international relations, have helped Romania’s economy in recent years. Romania’s real GDP growth slowed down from +7.1% in 2017 to +4.4% in 2018 and +4.1% in 2019, indicating that the previously overheating economy was heading for a reasonable soft landing. This outlook was spoiled by the arrival of the global Covid-19 crisis in Q1 2020, which has increasingly affected the Romanian economy via various channels since March: (i) supply-chain disruptions in the industry, notably the automotive sector; (ii) declining external demand; (iii) external confinement (border closures) and (iv) internal confinement (lockdown measures which were most stringent from end-March to early-May). Thanks to strong domestic demand in the first two months of the year, the economy still managed to post moderate positive growth in Q1. But high-frequency indicators suggest that output contracted sharply in March and then further by record rates in April. Although lockdown measures have been moderately eased since mid-May, we expect a gradual exit from the lockdown that lasts at least until the end of 2020.
Government instability, arrears of state-owned enterprises, banking sector vulnerabilities, high private-sector debt (notably in foreign currency), rapidly rising current account deficit, while net FDI inflows are declining, high external debt burden are already reported weaknesses that add to the effects of the COVID-19 crisis.
The analysis forecast annual GDP to shrink by approximately -5.5% in 2020, before recovering by +4% in 2021. This also means that the 2019 real GDP level will not be reached again before 2022 at the earliest.
Authorities are ready to stimulate but watch the exchange rate
Concerns over economic overheating in Romania persisted from 2017-2019, driven by surging wages, pro-cyclical fiscal stimulus and too loose monetary policies, which together resulted in rising inflation and widening twin deficits (on the fiscal and current accounts). The overheating worries have disappeared with the arrival of the Covid-19 crisis but the unfavorable economic development in the previous years left Romania going into the crisis with weaker macroeconomic fundamentals than most of its Central European peers.
Romania’s public finances will continue to deteriorate. Due to the strong pro-cyclical fiscal stimulus in recent years, the annual fiscal deficit widened rapidly from just -0.8% of GDP in 2015 to -4.3% in 2019. We expect this ratio to rise sharply to at least -8.5% in 2020 as a result of: (i) Covid-19-related fiscal stimulus (about 2% of 2019 GDP) and loan guarantees and subsidies for SMEs (about 3% of GDP) and (ii) lower nominal GDP.
In May 2020, Romania successfully sold EUR3.3.bn in 5-year and 10-year euro-denominated bonds, reflecting that it still has access to international markets to finance the stimulus, although at wider spreads than in January 2020. The government is also negotiating a World Bank loan worth around EUR1bn. And, if needed, an IMF loan may be sought in 2020 or 2021 and would probably be granted. Meanwhile, the downtrend in the public debt-to-GDP ratio in recent years will certainly reverse; we forecast an increase from 35% of GDP in 2019 to 50% by the end of 2021.
On a positive note, consumer price inflation moderated from 4.0% at end-2019 to 2.7% in April 2020 – now back into the 2.5% ± 1pp inflation target range of the National Bank of Romania (NBR, the central bank) – thanks to the deflationary effects from low oil prices and declining domestic demand. We expect inflation to remain within the target range until end-2021. This would allow further monetary easing by the NBR in 2020 in order to support the contracting economy, following the initial two cuts in its key policy interest rate to 1.75% (-50bp in March and -25bp in May). The NBR has also embarked on its first ever quantitative easing (QE) program, though it is much smaller than in advanced economies and with a focus on smoothing market variations, rather than large-scale asset purchases.
However, a downside risk to our outlook for inflation and monetary policy is provided by a potentially substantial depreciation of the leu (RON) in the event that investors lose confidence in Romania’s capacity to tackle the Covid-19 crisis. In recent years, the exchange rate of the RON has been fairly stable, despite the overheating of the economy in 2017-2018. The RON has depreciated between -1% and -2% on average p.a. vs. the EUR since 2016. This is an adequate performance for an emerging market. In the first five months of 2020, the RON lost around -4% vs. the EUR, but this was also moderate compared to many peers’ currencies, which lost much more in the wake of Covid-19. However, the NBR has continuously applied a range of tools to intervene in order to prevent excessive currency volatility – not surprising as the official exchange rate regime is that of a managed float. But it can only continue to do so as long it has sufficient foreign exchange (FX) reserves.
External deficit and debt are set to rise
Romania’s annual current account deficit widened from -0.2% of GDP in 2014 to -4.7% in 2019. Crucially, only 54% of that shortfall in 2019 was financed through net foreign direct investment (FDI) inflows, well below a comfortable level of 75% and down from a recent high of 192% in 2016. In Q1 2020, exports were harder hit than imports by the impact of Covid-19 and the current account deficit widened further compared to a year ago. Hence, we expect the full-year deficit to rise to about -5% of GDP in 2020 before narrowing to a still elevated -4% in 2021. Net FDI coverage of the deficit is forecast to fall well below 50% as the global crisis will slow down capital flows to emerging markets. Combined with the projected surge in the fiscal deficit, this could raise external financing needs to excessive levels. It could also reverse the downtrend in the external-debt-to-GDP ratio from 75% of GDP in 2012 to 48% in 2019 – we forecast a ratio of 56% in 2020.
Meanwhile, the NBR’s FX reserves have broadly moved sideward since 2016 in the range of 31-36 billion EUR, partly as a result of the aforementioned exchange rate interventions. More recently, reserves fell from EUR35.8 billion in February 2020 to EUR33.2 billion two months later. Overall, that means that the FX coverage of imports has fallen from a healthy 5.7 months at end-2015 to four months in April 2020. A further decline of that ratio could raise concerns among investors against the background of the rising twin deficits, expansionary fiscal policy and, in particular, the global recession triggered by Covid-19.
Trade structure by destination/origin (% of total)
Trade structure by product (% of total)
The complexity of the debt collection process
Although Romania’s regulations on late payments are more demanding than EU rules on the matter, the paying behavior of domestic companies remains problematic. Legal proceedings are long and costly, therefore use of arbitration or a foreign European forum is worth considering since both arbitral awards and decisions rendered in EU countries are fairly enforceable.
Before commencing legal actions of any kind, however, it is essential to conduct thorough pre-legal action. Indeed, as time goes on, chances are that bad payers will become insolvent. In such cases, recovering the debt becomes practically impossible.