Romania’s 2019 budget revisions could set stage for reassessment of sovereign credit risk, survey says

Romania’s government has passed a first revision of the 2019 budget in response to its widening fiscal deficit. Effective measures are needed given the country’s pro-cyclical fiscal policies and the upward trajectory of public debt, says Scope Ratings.

Romania’s (BBB-/ Negative) strongly pro-cyclical budget deficit has continued widening to an annualised 5.5% of GDP during the first quarter of 2019, by far the highest among EU members which have an average budget deficit of -0.6% – despite annual real GDP growth of 5%. Scope projects the mid-year budget deficit at close to 2% of GDP, which increases the government’s challenge in the next six months to achieve its self-imposed budget-deficit ceiling of 2.76%.

“More efficient tax collection, additional levies on consumption and better cost control are key for a more sustainable budget,” says Bernhard Bartels, lead analyst for Romania at Scope Ratings.

Romania’s public finances face two structural challenges over the medium-term: more effective revenue collection and keeping pension and wage growth under control. Fiscal revenues are among the lowest among the CEE countries (32% of GDP) and on a downward trend with low tax revenues (25.4% of GDP), while expenditures have grown strongly on the back of higher public sector wages (up 24% from last year). The adoption of the new pension law in June this year, which becomes effective in September, will further increase the fiscal cost by an estimated 0.8% of GDP. The National Fiscal Council projects the deficit to increase to around 4% in 2020 and 5% by 2021 if fiscal policies remained unchanged.

Scope expects public debt currently at 36% of GDP to increase towards 40% by 2020. Currently, the share of debt denominated in foreign currency is at 57.1% (17% of GDP), which could lead to a more pronounced debt-to-GDP increase if monetary policy remains expansionary, resulting in depreciation pressure for the Romanian leu against the euro once economic activity abates.

“At this stage of the economic cycle, the government faces a trade-off between stabilising the budget and avoiding a recession through large expenditure cuts. Its strategy seems to boil down to a mix of revenue-increasing measures and cuts to selected ministries’ budgets”, says Bartels.

Currently, the government has the benefit of higher-than-expected growth, supportive monetary policy and low refinancing rates, which help to contain the budget deficit. However, on the back of higher import growth, Romania’s current account deficit has widened to EUR 9.4bn in 2018, a level not seen since 2012.

The government would risk little popular political resistance if it tried to improve public finances by cutting back investment spending instead of recurrent expenditures, but there would be a significant longer-term cost. Romania has the third-lowest rate for absorbing EU investment funding (at 30.6% as of August 2019), which requires pre-financing and co-financing by the private sector for eligible investment projects which are prioritized by the local and national governments. Conversely, revoking the pension and wage bills risks losing the government’s voter backing, notably among its support base in the countryside.

The incumbent populist coalition formed by the social democrats (PSD) and the liberal ALDE party has lost ground after a defeat in European elections and the imprisonment of former PSD leader Liviu Dragnea on corruption charges. The government is reluctant to implement unpopular fiscal measures with presidential elections scheduled for the end of this year. After the announcement of PSD’s prime minister Viorica Dancila to run for the presidential election, tensions in the coalition government have intensified as both parties support different candidates.

“We expect that the government will succeed in achieving a 2019 deficit close to the 3%-limit through short-term adjustments, but it faces a bigger challenge next year given a growing pension burden and likely slowing growth,” says Bartels.

Scope’s concerns about the outlook for Romania’s public finances were reflected in the downgrade of the country’s credit rating in October 2018 to BBB- from BBB, with a Negative Outlook. Romania’s sovereign outlook could be stabilised if effective policymaking led to a strong improvement in the government’s fiscal framework and/or a firm downward path for the public debt trajectory.