EC: Strong growth for Romania ahead amid fiscal loosening. Inflation to turn positive in 2016. Law on debt discharge, major risk

Driven by wage increases and fiscal relaxation, Romania’s economic growth is forecast to peak in 2016 before moderating somewhat in 2017, European Commission (EC) notes in its Winter 2016 Economic Forecast released on Thursday.

The officials in Brussels appreciates that the 4 percent reduction of the standard VAT rate in January 2016 along with negative inflation and a 19 percent increase in the minimum wage from May 2016 are projected to boost consumption and push growth up to 4.2 percent in 2016.

“As inflation picks up and the fiscal stimulus fades in 2017, consumption growth is likely to slow down. GDP growth, however, is expected to remain above potential at 3.7 percent in 2017,” an EC reports reads.

According to the EC report, stable investor confidence and continued growth in local currency lending as well as the abolition of the construction tax from 2017 should help to sustain private investment growth over the forecast horizon.

Annual average inflation is forecast to reach -0.2 percent this year. As the impact of the VAT cuts fades out and the output gap closes, inflation is set to return to positive territory in the second half of 2016, an EC report said. It is forecast to re-enter the central bank’s target band (2.5 percent ± 1 pp.) in 2016 and to reach an annual average of 2.5 percent in 2017.

A major downward risk to the macroeconomic outlook is the potential implementation of the law on debt discharge as initially approved by Parliament, the EC warns.

“The retroactive application of the law on the current stock of loans could have a negative impact on credit growth, consumer and investor confidence, and domestic demand. Upward risks could come from a better-than-expected absorption of EU funds and a higher multiplier effect from the fiscal stimulus in 2016 and 2017,” the report reads.

Fiscal deficit to increase substantially

In 2016, the headline deficit is expected to increase to 3 percent of GDP and in 2017, is projected to deteriorate to 3.8 percent of GDP.

“An additional cut in the standard VAT rate from 20 percent to 19 percent, the abolition of the extra excise duty on fuel and of the special construction tax, and further new Personal Income Tax (PIT) exemptions are expected to have a negative impact on revenue,” the Brussels-based institution pointed out.

At the same time, Romania’s debt-to-GDP ratio is projected to rise from 39 percent in 2015 to 42.6 percent in 2017. The main downward risk to the fiscal outlook in 2017 and beyond stems from an envisaged new public wage grid, EC concluded in this respect.

Downward trend in unemployment to continue

As regards the labour market, the EC expects the downward trend in unemployment to continue, supported by strong economic growth. “The 19 percent increase in the minimum wage in 2016 is expected to lead to higher unit labour costs overall. The wage hike will partially offset recent gains in productivity, thereby weighing on competitiveness,” the quoted document also reveals.