Fitch Ratings has affirmed on Friday 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 rating peers and pro-cyclical fiscal policy that poses risks to macroeconomic stability, a release on the agency’s website reads.
A loosening in fiscal policy since 2016 has weakened the public finances. Outturns for the first nine months of 2018 show revenues were just 69% of the revised full year targets and the budget deficit was 1pp of GDP higher than the corresponding period in 2017. Nevertheless, Fitch expects the government to meet its 2018 general government budget deficit target of 2.96% (ESA basis) through deferring capital expenditure and ad hoc measures, as in 2017, so as to avoid the EU placing it in the Excessive Deficit Procedure. The structural deficit estimated by the European Commission widened to 3.4% of GDP in 2017 from 0.2% in 2015.
The government has not yet submitted its draft 2019 budget to parliament, but it has indicated that no major tax changes are planned and has already legislated for a 10% public wage rise in January and a 15% pension hike in September. The deficit targets outlined in its letter of 18 October 2018 to the EU were 2.4% for 2019, 1.8% for 2020 and 1.5% for 2021, based on its view of potential real GDP growth of around 5%. In Fitch’s view, these will not be possible to meet without new fiscal consolidation measures. There is a limit to how much further the government can squeeze capital expenditure and rely on ad hoc measures. We are forecasting deficits of 3.5% of GDP in 2019 and 2020.
The structure of the public finances is becoming more rigid, with the share of wages and social security payments rising to 57% of total expenditure in 2018. The current pension law builds in a 70% increase in the pension point (the main parameter used for state pension indexation) over 2019-2021. Cuts to VAT and personal income tax rates since 2016 have reduced revenue/GDP to an estimated 30.9% in 2018, from 35.5% in 2015, despite the cyclical economic boom.
Fitch forecasts general government debt at 35.0% of GDP at end-2018, virtually unchanged from 35.1% at end-2017, helped by projected nominal GDP growth of 10%. This compares with the current ‘BBB’ range median of 39% of GDP. Nevertheless, we forecast the debt ratio to start rising from 2019 as the budget deficit widens, growth slows and interest costs rise. The government has deposits equivalent to around 6% of GDP at end-2017 and the average maturity of government debt is 6.2 years.
Risks of the Romanian economy overheating have declined as the pace of GDP growth has slowed since 2017, the National Bank of Romania (NBR) has tightened monetary policy and headline inflation has started to fall (although at 4.25% in October, it remains above the NBR target of 2.5%+/-1pp). Nevertheless, rapid wage growth in excess of productivity growth, a positive output gap, expansionary fiscal policy and a widening current account deficit mean that some risks remain.
GDP rebounded to 1.5% (qoq seasonally adjusted) in 2Q18 from 0.3% in 1Q18 and 0.4% in 4Q17, easing but not eliminating the risk of a ‘hard landing’ of the economy. The yoy growth rate dropped to 4.3% in 2Q18 from a recent peak of 8.4% in 3Q17. The composition of yoy growth in 1H18 points to some strains, with contributions of 2.4pp from stock-building (which could reflect measurement issues) -1.6% from net trade and just 0.1% from fixed capital formation. Preliminary data for 3Q18 (released after Fitch finalised its forecasts) showed strong qoq growth of 1.9%, which was surprising given the 0.2% contraction in industrial production and the weak trade performance.
Fitch’s base case is a relatively soft landing with annual average growth forecasts of 3.5% in 2018, 3.2% in 2019 and 3.0% in 2020, reflecting a slowdown in EU growth, monetary tightening, a fading of the fiscal stimulus and lack of spare capacity. However, there is a risk of a more abrupt slowdown in the event of an external shock, loss of competitiveness from double-digit wage growth or marked tightening in fiscal or monetary policy.
Fitch forecasts the current account deficit (CAD) to widen from 3.2% of GDP in 2017 to 4% in 2018 and 4.3% in 2019. In January to September 2018, the CAD widened by 39% yoy in euro terms as domestic demand growth in Romania exceeding that in trading partners.
Moreover, net equity FDI covered only 47% of the CAD in the first nine months of 2018, down from 65% in the same period in 2017, making deficit financing more dependent on debt inflows. Based on these trends, we forecast net external debt/GDP to plateau at around 19%-20% over the forecast horizon, well above the current ‘BBB’ range median of 8%.
Romania’s banking sector remains stable. Banks are well-capitalised, with an average capital adequacy ratio of 20.1% (June 2018). Liquidity is also ample, with a loan-to-deposit ratio at 86.9% (August 2018). Meanwhile, asset quality continues to improve, with non-performing loans declining to 5.7% of total loans (June 2018) from 9.6% at end-2016.\
Romania’s percentage ranking in the World Bank’s composite governance indicator declined by 1.4pp in 2017 to the 58th percentile among sovereigns (data released in September 2018), taking it marginally below the ‘BBB’ range median. The government has been seeking to pass various legal changes and appointments, many of which have been criticised by the EC, and which have triggered public protests. Liviu Dragnea, head of the ruling PSD, has been embroiled in a number of corruption legal cases. Romania faces a busy electoral calendar over 2019-20, which provides a challenging backdrop for fiscal consolidation, the release reads.