CEE countries might face EU fund cuts, Romania, Bulgaria might be the exceptions, European credit rating agency says

Central and Eastern European EU members face a possible reduction in investment over 2021-27. Improving effectiveness in deploying EU funds and enhancing long-term growth now become more important for their economic convergence and credit outlooks, reads a Scope new report.

More than half of the EU’s budget for 2014-20, worth EUR 461bn, is channelled through the European structural and investment funds to foster economic sustainability, job creation and innovation in the EU. CEE countries jointly account for nearly half of this amount. Assessed as a percentage of 2018 GDP, the financial allocations for 2014-20 period range from up to 8.6% for Slovenia (A/Stable) to up to 20.8% for Croatia (BBB-/Stable).

“The European Commission’s proposal for the new 2021-27 budget has two major repercussions for the CEE region,” says Levon Kameryan, analyst at Scope Ratings.

Brexit, if it happens, and proposed EU funding changes for the 2021-27 period suggested by European Commission (EC), if implemented, are set to significantly reduce EU fund allocations to CEE. Bulgaria and Romania would be the only two CEE countries that would likely see their fund allocations increase.

Scope views EU fund absorption to be an important rating driver for CEE countries, as it not only accounts for a crucial share of public investments for infrastructure and innovation, but also stimulates governments’ long-term planning, governance and administrative capacity to use public funds effectively. Scope’s assessment of these developments is captured, for instance, in the rating actions on Hungary (BBB/Positive), Romania (BBB-/Negative) and Croatia.

First, the European Commission (EC) has proposed new criteria to be included in the funding rules for 2021-27, based on metrics including youth employment, integration of migrants, climate change, and education. Secondly, the EC’s proposal assumes the complete loss of EU budget contributions from the UK, whose contribution to the 2014-20 budget is projected to be around 12% of the total, according to official estimates. Compared to the 2014-20 period, these combined changes would imply a reduction of around EUR 35.5bn in funding for the CEE region, but an increase in funding for the southern periphery – e.g. Greece, Italy, Spain, Cyprus – by EUR 5.3bn.

Scope expects the EC’s proposals to be amended by the European Council as well as the European Parliament in coming negotiations. The size and allocation of the budget and the resulting implications for CEE countries are thus likely to still change meaningfully.

“The general allocation of the ESI funds is obviously important, but so too is the national spending strategy and the ability of governments to deploy the funds fully and efficiently,” says Kameryan.

“The experience over the 2014-20 EU financing period shows a wide disparity of results across the CEE region, with Estonia, Latvia and Lithuania the most successful in putting EU-funded programmes into place,” says Kameryan. After the Baltic states come Poland, Hungary, Slovenia, Bulgaria, Czech Republic, Romania, Slovakia and Croatia.

Boosting R&D investment levels, which are low and lagging materially behind that in western European countries, as well as expenditure on education, partly through the higher take-up of EU funds, will be an important step towards increasing long-term returns from future EU-backed projects in CEE,” he says.

“The absorption of EU funds is an important rating driver for CEE countries in that the funds account for a large share of public investments – important for improving infrastructure and productivity – while also stimulating the governments’ long-term planning, governance and administrative capacities to use resources effectively,” he says.

Greater use of EU funds in Hungary – potentially accounting for 54% of all public investment over 2014-20 – underpinned Scope’s decision to change the Outlook on the sovereign’s BBB rating to Positive in February 2018. Conversely, the absence of a strategic management framework in Romania (BBB-/Negative) and the high fragmentation of public administration in Croatia help explain the countries’ poor records in investing EU funds and constrain their sovereign outlooks.

Scope Ratings GmbH is a European credit rating agency, part of the Scope Group with headquarters in Berlin and offices in Frankfurt, London, Madrid, Milan, Oslo and Paris.

Public investment in Romania (BBB-/Negative) fell to its post-EU accession low in 2017, at 2.6% of GDP, with a low take-up of EU funds16, accounting for only quarter of the country’s public investment since 2014. According to Scope, the country’s potential for even stronger growth is limited, given its large labour-skills mismatch and low funds absorption rate. This reflects the country’s high political turnover, absence of a strategic management framework and lengthy tender procedures17. These factors have contributed to Scope’s assignment of a Negative Outlook after downgrading the credit rating one notch to BBB- in October 2018.

Scope downgraded Romania’s credit rating to BBB- from BBB in 2018.

You can download the Scope report here.