S&P says Romania’s outlook is stable at ‘BBB-/A-3’, external debt is likely to increase

Standard & Poor’s (S&P) affirms Romania’s rating at BBB-/A-3, with a stable outlook, warning about country’s budget and trade deficits widening.

”The stable outlook reflects our expectation that while Romania’s twin deficits will widen as a result of the Government’s procyclical fiscal stance, general government and external debt will increase only gradually in the coming years – barring a major economic slowdown,” S&P notes.

Moreover, Romania’s procyclical budgetary stance is amplifying wage pressures in an already overheating economy. While wage convergence is desirable, pay increases that significantly outpace underlying productivity have historically led to boom-bust cycles.

S&P also said it expects the consumption-focused growth to generate wider fiscal and external deficits, increasing the economy’s vulnerability to an abrupt downturn over the medium term, though public and external debt is modest.

S&P analysts point out that they could raise the ratings if Romania’s government made more sustained headway with budgetary consolidation and put net general government debt firmly on a downward trajectory, including by successful restructuring on privatization of public enterprises; and if Romania’s governance framework improved, translating into more predictable and stable macroeconomic growth and government finances.

”We could lower the ratings on Romania of we considered that policy reversals could cause general government deficits, debt and borrowing costs to deteriorate significantly. Moreover, we would consider a negative rating action is Romania’s external imbalances re-emerged, in particular if an uncertain political environment led to lower foreign direct investment (FDI) inflows, implying that Romania’s widening current account deficit would increasingly have to be financed with debt-creating inflows,” rating analysts also stressed.

S&P expects the fiscal deficit to stay elevated this year and may even surpass the 3 percent of GDP deficit target set out by the EU’s Maastricht criteria, due to a slightly lower growth forecast. ”We flag some measures the government has already implemented to remain around 3 percent fiscal deficit level in 2017, which in our view are not sustainable ,” the analysts show.

Rating agency also forecast Romania’s debt to surpass 40 percent of GDP by 2020 and an average current account deficit above 4 percent of GDP over S&P forecast horizon. ”We expect that this current account deficit will remain overfunded by surpluses on the capital and financial account as EU fund absorption accelerates and FDI remains steady,” S&P also notes.

Overall, Romania’s predominantly foreign-owned banking sector remains sound, since the system’s loan-to-deposit ratio declined to just over 80 percent at end-2016, down from its peak of 137 percent in 2008. Romania continues to operate a managed float of the Romanian leu under an inflation-targeting regime.

”While inflation has remained outside the National Bank of Romania (BNR)’s target band for the past three years, we expect it will gradually increase and reach the upper end of the target by year-end 2018. The fading out of the effects from cuts to administered prices and imported prices, paired with strong wage growth, should drive up inflation,” S&P concluded.