Fitch affirms Romania at ‘BBB-‘, outlook stable, expects budget deficit to widen

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Fitch Ratings has affirmed Romania’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘BBB-‘ with a Stable Outlook.

Romania’s investment-grade ratings are supported by moderate levels of government debt, and GDP per capita and human development indicators that are above ‘BBB’ category peers. These are balanced against twin budget and current accounts deficits, net external indebtedness that is higher than its rating peers and pro-cyclical fiscal policy that poses risks to macroeconomic stability, a release posted on Friday on the agency’s website reads.

The government’s 2019 budget foresees a narrowing of the general government deficit to 2.8% of GDP from 3.0% in 2018 (versus a ‘BBB’ peer median deficit of 1.9%). However, the projected revenue increase (15.7%) appears highly optimistic, as Fitch believes it relies on unrealistic macroeconomic assumptions, including private employment growth of over 3.0% (it expanded by 1.7% in 2018). The Fiscal Council has also identified under-budgeting of goods and services and interest payments costs, which could lead to higher spending. In previous years the government has been able to meet its targets by containing capital investments (according to Eurostat figures, capital investment in accrual terms was 2.7% of GDP in 2018, the same rate as in 2017 and lowest figure since 1999). However, Fitch believes this strategy is reaching its limit and we expect the deficit to widen to 3.4% of GDP in 2019.

Fiscal loosening could continue in 2020 and beyond, in particular if the government moves ahead with plans to increase pensions by a further 40% in September 2020 (following a 15% approved for September 2019). In the absence of revenue raising reforms we estimate the deficit to widen to 4.0% of GDP in 2020, which would lift the public debt/GDP ratio to 37.9%, from 35.0% in 2018, although this is still slightly below the projected BBB median of 38.8%. Risks are on the downside and are partly tied to unpredictable policymaking, especially given the busy electoral cycle in the next two years.

The authorities’ implementation of a controversial emergency tax ordinance in December 2018 and the reversal thereafter of some of the measures – following pressure from National Bank of Romania (BNR) and private sector – highlight the weakness of the fiscal policymaking framework and the challenges the government faces in lifting revenue to match expenditure promises. Fitch assesses the fiscal impact of the revised measures to be very limited, in particular the watered-down bank asset tax (0.4% for those with market share of over 1% and 0.2% for those below 1%), which has in any case been excluded from the budget. However, there is a risk of fallout in terms of adverse impact to business environment, investment and economic growth.

For the banking sector, the new tax should dent profitability only very slightly, with Fitch expecting broad stability in the industry. Capital adequacy remains high (19.7% at end-2018), the ratio of non-performing loans continues to decrease (4.8% in February 2019 from 6.4% at end-2017) and there is ample liquidity. The credit cycle appears moderate in the context of very rapid economic growth in recent years, with lending to private sector rising by a total of 7.9% in 2018 and 13.2% in local currency (versus nominal growth of 10.2%). This helps reduce risks of credit-bubbles and negative spill-overs to the wider economy.

Fitch continues to forecast a gradual slowdown in economic activity in 2019-2020, with GDP growth averaging 3.1%, broadly in line with the current ‘BBB’ peer median but compared with 4.6% in 2013-18. Private consumption has been the main driver of headline growth since 2014 and we expect this trend to continue over the medium term, albeit at a slower pace given lower projected wage increases. Investment should recover in 2019-2020–it contracted in 2018, partly due to cyclical trends in sectors such as construction–thanks in part to higher absorption of EU funds. However, this should largely be offset by a negative contribution of net trade, as strong domestic demand continues to drive robust import growth. Given net population loss, GDP per capita should continue to increase steadily, narrowing the gap with the rest of the EU (it reached 65% EU average in purchasing power terms in 2018).

Headline inflation averaged 3.7% in 1Q2019, above the 3.5% upper limit of the NBR, due mainly to upward pressure from volatile non-core price components. Core inflation has been more stable (it averaged 2.6% in 1Q19, compared with 2.8% for 2018). Given lower headline GDP growth, Fitch expects inflation to moderate and average 3.3% in 2019-20, although there are upside risks given strong wage growth. The real policy rate remains negative, but the NBR has continued to tighten it since mid-2017 via increases in the interbank rate and deposit lending facilities.

The current account deficit (CAD) widened to 4.5% of GDP in 2018, the largest since 2012 and compared with the current peer median of 1.0% of GDP. This reflects strong growth in imports of goods and services and stagnating current transfer credits. We forecast a further widening of the CAD to 5.5% of GDP in 2020, primarily the result of a wider trade deficit. Rapid wage growth in excess of productivity growth–nominal unit labour costs growth at 14% in 2018 was the highest in the EU-risk eroding cost competitiveness, contributing to the widening in the CAD.

Strong nominal GDP growth and external deleveraging in the banking sector reduced the level of net external debt to 15.7% at end-2018 (although it is still double the current ‘BBB’ range median). However, this trend is set to reverse in 2019-20 as the wider CAD needs to be partly funded by debt-creating flows. Non-debt creating inflows (net equity FDI and capital transfers) covered the entire CAD in 2013-17 but only 70% in 2018. We forecast this ratio to fall further to only 60%, even though capital transfers are set to increase in line with higher EU transfers.

Romania’s percentage rankings in the World Bank’s composite governance indicator are broadly in line with the ‘BBB’ range median. However, the busy electoral calendar over 2019-20 (which include EU, presidential and parliamentary votes) provides a challenging backdrop for orthodox economic policy implementation. In addition, concerns surrounding corruption cases affecting top public officials risk fuelling political and social tensions, the release reads.

Fitch’s proprietary SRM assigns Romania a score equivalent to a rating of ‘BBB+’ on the Long-Term Foreign-Currency (LT FC) IDR scale.

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